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China’s central bank has taken an unexpected step by cutting key policy rates for the second time in three months, signaling an intensified effort to stimulate a sluggish economic recovery.
Financial analysts believe this move might lead to a potential reduction in China’s lending benchmark loan prime rate (LPR) in the following week.
The decision to cut rates was prompted by tumbling credit growth and the growing risk of deflation in July. These factors, along with concerns about default risks among housing developers and payment issues with a private wealth manager, have impacted the confidence of financial markets.
Tommy Wu, Senior China Economist at Commerzbank, noted, “All of these add to the urgency that policymakers need to act fast before consumer and business confidence deteriorate sharply.”
The People’s Bank of China (PBOC) announced that it had reduced the rate on 401 billion yuan ($55.25 billion) worth of one-year medium-term lending facility (MLF) loans to select financial institutions by 15 basis points, bringing it down to 2.50% from the previous 2.65%.
The PBOC stated that this injection of cash aimed to counteract various factors, including tax payments, to maintain reasonably ample liquidity in the banking system.
Surprisingly, in a recent Reuters poll of 26 financial experts, 20 participants (77%) predicted that the central bank would keep the MLF rate unchanged. Only six respondents anticipated a minor rate reduction.
Ken Cheung, Chief Asian FX Strategist at Mizuho Bank, suggested, “The surprising rate cut was a prompt response to support subdued credit data and China recovery (that) may unleash yuan depreciation pressure towards 7.3.”
Cheung also highlighted the possibility that the PBOC intends to support medium-term credit conditions via the rate cut. This move could potentially pave the way for a cut in the LPR, particularly the 5-year LPR, aiming to assist the struggling property sector.
The MLF rate often guides the LPR, and markets typically consider the medium-term policy rate as a precursor to any changes in lending benchmarks. The monthly LPR adjustment is scheduled for the upcoming Monday.
In addition to the rate cut, the central bank injected 204 billion yuan through seven-day reverse repos while reducing borrowing costs by 10 basis points, bringing it down to 1.80% from the previous 1.90%.
While other major economies are tightening their monetary policies to combat high inflation, China remains an outlier by loosening its monetary policy to boost a faltering recovery.
This rate adjustment further widens the yield gap between China and other major economies, placing more pressure on the yuan and potentially leading to capital outflows.
China’s yuan has experienced a decline of about 5% against the dollar this year, making it one of the weakest-performing Asian currencies. As of 0145 GMT, the yuan was trading at 7.2842 per dollar, compared to the previous close of 7.2580.
Furthermore, yields on China’s 10-year government bonds have eased to 2.56%, marking the lowest level since May 2020.
The Central Bank’s decision to lower key policy rates in June was intended to support the broader economy, but subsequent data has shown increasing weakness.
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