China central bank skips rate cut in policy surprise

SHANGHAI – China’s central bank held a key interest rate steady on Jan 15, while still pumping more cash into the financial system, bucking expectations that it would cut borrowing costs to support the economy.

The People’s Bank of China (PBOC) maintained the rate on its one-year policy loans – called the medium-term lending facility (MLF) – at 2.5 per cent, contrary to widespread expectations among economists that it would make its first trim to the rate since August.

It also offered 995 billion yuan (S$186 billion) through the MLF, resulting in a 216 billion yuan net injection that will boost liquidity and help meet funding demand.

Still-stubborn inflation in the United States has led to uncertainty over when the Federal Reserve will start reducing its interest rates. After December consumer prices came in a bit hotter than expected, Fed Bank of Cleveland president Loretta Mester said that March was “probably too early” for a rate decline.

“Chinese policymakers here are signalling essentially that, look, we are not quite clear that the Fed’s going to cut rates soon, so maybe we’re going to hold off,” said HSBC Holdings chief Asia economist Frederic Neumann.

Pointing out that there is still a big interest rate differential between the two economies, he said: “You don’t want to cut too rapidly in China, and so you might want to use liquidity injections and other types of credit-easing tools rather than an outright rate cut at this point in time.”

Economists cited a slew of other considerations for the central bank that may have held it back from cutting rates, including concerns over the renminbi’s strength and the potential for a rate cut to create volatility.

Banks are also experiencing record-low net interest margins, meaning they may need more time to reduce their funding costs before being able to absorb the impact of lower borrowing rates.

Recent economic data out of China has raised concerns about the recovery’s momentum, leading investors and analysts to heighten their expectations for more policy easing.

The country marked its longest deflationary streak since 2009 in December, figures released on Dec 12 showed. Exports fell annually in 2023 for the first time since 2016 due to weak global demand. Financing and loan growth in December missed expectations. Weak domestic demand, a prolonged property crisis and the sluggish job market remain major overhangs in 2024.

“In the light of the weak data, a cut would probably have undermined the yuan and led to unwanted currency weakness,” said Mr Robert Carnell, regional head of research for Asia-Pacific at ING Groep. “I think the authorities are quite constrained with what they can do, and so I’m neither disappointed nor surprised, but I am resigned to this being another difficult year.”

Several economists do not think cutting policy rates would solve the demand and confidence problems, though, even if such actions are able to ease some financing pressures in the short term.

That has led to focus on other tools at its disposal that help ensure ample market liquidity. The PBOC may, for example, cut the reserve requirement ratio (RRR), or the amount of cash that banks must hold in reserve, especially after a senior central bank official mentioned that ratio in an interview with state media last week.

While not as aggressive a move as a policy rate cut, reducing the RRR would unleash money into the financial system, thereby helping banks buy government bonds that would be issued to finance infrastructure spending.

The central bank also took several fairly aggressive steps in December to support the economy, short of a rate cut. It rolled out a record 800 billion yuan via the MLF to lenders, and injected more cash into the banking system. The PBOC also provided policy-oriented banks with 350 billion yuan worth of low-cost funds in the same month to finance housing and infrastructure projects.

Once the Fed does start cutting rates, though, the room for rate trims in China will open up.

“A turn of the Fed’s policy stance will soon bring an end to the PBOC’s painful period of monetary policy divergence with all major central banks in the world,” said Ms Becky Liu, head of China macro strategy at Standard Chartered Bank.

“A dovish turn of the Fed will offer more room for the PBOC to ease in 2024 to better reflect China’s economic and inflation fundamentals.” BLOOMBERG