China’s Surprise Rate Cut Fuels Expectations of More Easing

(Bloomberg) — China’s central bank surprised most economists and market participants by cutting a short-term policy interest rate, a sign that officials are increasingly concerned about faltering growth and are stepping up stimulus to boost the recovery.

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The People’s Bank of China lowered the seven-day reverse repurchase rate by 10 basis points to 1.9% on Tuesday, the first reduction in the rate since August 2022. That increases the likelihood the central bank will reduce its one-year loan rate on Thursday, with banks expected to lower their lending rates shortly after.

Tuesday’s move underlines heightened concern about a slowdown in growth: recent economic indicators showed inflation remained near zero in May, manufacturing activity contracted and an early rebound in the property market has fizzled. Speculation is growing that the PBOC may cut interest rates even further this year, while Beijing is considering a broad package of stimulus measures.

“Policymakers are finally acknowledging the economic weakness,” said Michelle Lam, Greater China economist at Societe Generale SA. “There should be more interest rate and reserve requirement ratio cuts in the second half of 2023.”

Goldman Sachs Group Inc. economists forecast a 25 basis-point cut to the reserve requirement ratio for lenders — which will free up more money for banks to boost lending — in the third quarter. Another cut to the ratio or policy rates could happen in the fourth quarter depending on the economy’s performance, they wrote in a research note Tuesday.

Macquarie Group Ltd. expects a 10 basis-point cut in the one-year medium term lending facility rate in the third quarter after a cut later this week.

Muted Response

A gauge of Chinese stocks listed in Hong Kong was up 0.4% at the mid-day break, boosted by tech shares. Property stocks — which rallied immediately after the cut, pared more of the gains, with a gauge of developers up just 0.3%.

While rate cuts may help sentiment in the short term, economists say more needs to be done to boost confidence for businesses to invest. Borrowing demand remains weak, and rapid growth in money supply alongside sluggish private investment means monetary easing alone won’t do much to stimulate the economy.

“A rate cut is not enough to lift the market,” said Steven Leung, executive director at UOB Kay Hian. “Market needs to see more policy support, both monetary and fiscal, before turning around bearish sentiment on China’s economic outlook.”

The timing of Tuesday’s move suggests the PBOC may be trying to get “ahead of the curve” and the US Federal Reserve’s upcoming policy meeting “to mitigate the rate cut impact on the yuan,” said Ken Cheung, chief Asian FX strategist at Mizuho Bank Ltd. in Hong Kong. Economists expect the Fed to finally pause its aggressive rate-hiking cycle this week.

A Fed hold may lessen any impact that PBOC easing measures have on capital outflows and the yuan, which has weakened against the dollar by 3.6% this year and is one of the worst performing Asian currencies.

The offshore yuan on Tuesday weakened to a six-month low after the short-term policy rate cut, approaching the closely watched 7.2 per US dollar level. The yield on 10-year government bonds fell five basis points to 2.62% just before noon local time, set for the lowest since September.

Loan Rates

Tuesday’s rate cut came as a surprise as the PBOC rarely moves the short-term policy rate before the one-year rate. The last time that happened was in March 2020.

Policy rate cuts pave the way for a lowering in loan prime rates when those de facto benchmark lending rates are announced next week, economists say. The LPRs are based on the interest rates that 18 banks offer their best customers, and they usually move in tandem with the MLF rate.

Authorities recently guided major banks to lower their deposit rates, which could help them preserve margins and cope with lower lending rates.

What Bloomberg’s Economists Say …

“The People’s Bank of China decision to cut the 7-day reverse repo rate by 10 basis points is a clear sign it will make an equivalent trim to its medium-term lending facility — the key rate — on June 15. The PBOC usually adjusts the tools at the same time. Moving sooner on the repo rate is significant. We think it shows that the central bank wanted to give early guidance and assure the market of its easing stance, given the weakness of the economy’s post-Covid rebound.”

— David Qu, economist

Read the full report here.

PBOC Governor Yi Gang last week vowed to step up “counter-cyclical adjustments,” a shift in language that some analysts said signaled more easing. He also pledged to “make all efforts to support the real economy” as the recovery in demand has lagged that of supply.

Beijing has taken a measured approach to monetary and fiscal stimulus this year, preferring targeted steps that help boost specific sectors of the economy in need of aid, like small businesses. In recent weeks, officials outlined incentives to boost the consumption of electric cars and other types of vehicles, while the government is also mulling a property market support package, according to people familiar with the matter.

Along with the data on industrial production, retail sales and investment set for release Thursday, other indicators this week may also be grim.

“The May credit data that may be released today or tomorrow could be very bad,” said Xing Zhaopeng, senior China strategist at Australia & New Zealand Banking Group Ltd., referencing expected figures on credit and new loans. “The PBOC may be worried about the potential shocks to the market and so it took this opportunity to try to appease concerns in advance.”

–With assistance from Tian Chen, Ishika Mookerjee, Chester Yung and Charlotte Yang.

(Updates with latest Goldman Sachs forecasts.)