China Cuts Interest Rates, More Easing To Come

The Chinese central bank’s announcement to cut policy rates is not surprising given the country’s weak economic fundamentals, but monetary policy easing so far has limited impact on improving the growth momentum, pointing to an ineffective policy transmission process, says a report by ANZ.

The People’s Bank of China said tonight that it would cut policy rates by 25 basis points, effective from June 28. After this cut, one-year deposit and lending rates will be lowered to 2.0% and 4.85%, respectively.

In the meantime, the PBoC will conduct targeted reserve requirement ratio (RRR) cut towards financial institutions. For commercial banks that meet certain level of loans to agricultural and small and medium enterprise sectors, the RRR will be lowered by 50 basis points. The central bank will also cut the RRR for financial companies by 300 basis points.

This is not surprising given that real activity indicators remain weak in April and May, and indicate that China’s economy may have missed 7.0% growth target in the second quarter.

In fact, the PBoC resumed reverse repo operations in the past week, and increased the size of the Mid-term Lending Facility (MLF) recently. All these suggest that China’s monetary policy will remain accommodative.

However, the monetary policy easing so far has limited impact on improving the growth momentum, may be due to an ineffective policy transmission process.

While the liquidity conditions remain extremely relaxed in the inter-bank market, commercial banks are still reluctant to provide loans at a lower price to corporates due to credit concerns. As a result, real interest rates faced by Chinese companies are still above double digits.

The PBoC also acknowledged that and said that it has to rely on policy rate adjustment to force banks to lower the cost of loans. In the meantime, the central bank also argued that a universal cut of the RRR will have limited impact, as commercial banks are holding large amount of cash on their balance sheets and inter-bank market interest rates have been an extremely low level since March.

Therefore, the central bank conducted selective RRR cuts to encourage banks to provide funds to real economy.

The stock market crash on Friday also has affected today’s policy decision. While the PBoC already had a policy bias to ease, a booming stock market has delayed the timing of further monetary policy ease due to the concern of stimulating the equity market further.

Today’s rate cut and targeted RRR cut can have a "one stone two birds" effect, that is, it allows the PBoC to ease policy to boost the sluggish economy while sending a policy signal that authorities do not want to see a bear equity market, either.

Looking ahead, the PBoC will intensify the effort to improve the policy effectiveness, says the report. ANZ forecasts that the central bank will cut the RRR by another 100 basis points before the end of this year, if the capital outflow continues the pace seen in the first quarter.

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