China Drops One-Year Policy Loan Rate Ten Basis Points

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In the first instance since January, China’s central bank cut a key policy rate in a effort to boost an economy which the latest numbers show may be beginning to slump.

On Monday, in a surprise move, the People’s Bank of China dropped the one-year policy loan rate 0.1% to 2.75%. A Bloomberg poll of 20 economists had forecasted there would be no change in the medium-term lending facility loan rate, with policy makers leaving it at 2.85%. The seven day reverse repo rate was also dropped from 2.1% to 2%.

After the surprise move, China’s ten-year government bond rate dropped 0.4%, to 2.69%. After opening lower, stocks rebounded, with the CSI 300 Index up 0.3% as of 9:36AM in Shanghai.

Xiaojia Zhi, an economist at Credit Agricole said the rate cut, “shows that the Chinese authorities are still deeply concerned about growth and sluggishness in credit demand, while inflation pressure is mild.”

At the same time, the central bank issued 400 billion yuan of MLF funds, only partly rolling over 600 billion yuan of loans which were maturing this week, in an effort to withdraw liquidity from the banking system. This was a move that had been expected by economists.

The central bank made the move shortly before the release of government economic data which is expected to show a somewhat mixed recovery, with high unemployment, a weakened property sector, but somewhat improved industrial output and retail sales.

How far the improvement in industrial output will go is up for grabs, with a Bloomberg survey of export managers finding overseas orders are declining as inflation saps consumer’s pocketbooks across the globe. According to Wendy Ma, marketing manager at a textile maker in the eastern city of Ningbo, “Consumers don’t have the money to spend with soaring inflation,” and this has produced a sudden decline in orders for items including buttons, zippers and sewing thread. She noted orders for those items plunged roughly 30% in July and August compared to a year earlier due to declining demand from major markets like the US and Europe.

In addition, a fresh Covid outbreak in Hainan Island which has seen cases rise to a three month high, is also muddying the waters around China’s immediate economic future.

On Friday data came out showing weak credit growth for July due to new loans and corporate bond issuance slowing. That data has economists worried China may be entering a liquidity trap, where monetary easing has lost the ability to trigger the borrowing that can spur the economy.

Ken Cheung, chief Asian FX strategist at Mizuho Bank Ltd. said, “Despite the warning of structural inflation and ample liquidity condition, the dominating downside risk for growth and weak credit data prompted the PBoC to lower the policy rates.”

The drop in rates highlights the different path China’s policymakers have chosen, as well as the risks China faces going forward. As most central banks are tightening policy, China’s is loosening it, posing risks for the yuan by devaluing it and increasing capital outflow pressures. It is surprising, given the PBOC just recently warned of the risk of rising inflation.

The rate reduction being enacted in spite of the risks, speaks to the growth challenges China faces. Although last month top leaders vowed to pursue “the best outcome” possible for economic growth while maintaining a strict, “Zero Covid” strategy, the nation has had to downplay its 5.5% growth target, as economists now forecast growth for the year most likely coming in at around 3.8% this year.

The Daily Financial Trends