China surprises with cuts to key rates to support weak economy

SHANGHAI - China surprised markets by lowering a key short-term policy rate and its benchmark lending rates on July 22, in efforts to boost growth in the world’s second-largest economy.

The cuts come after China last week reported weaker than expected second-quarter economic data and its top leaders met for a plenum that occurs roughly every five years.

The country is verging on deflation and faces a prolonged property crisis, surging debt and weak consumer and business sentiment. Trade tensions are also flaring, as global leaders grow increasingly wary of China’s export dominance.

“The cut today is an unexpected move, likely due to the sharp slowdown in growth momentum in the second quarter as well as the call for ‘achieving this year’s growth target’ by the third plenum,” said Macquarie chief China economist Larry Hu.

The People’s Bank of China (PBOC) said it would cut the seven-day reverse repo rate to 1.7 per cent from 1.8 per cent, and would also improve the mechanism of open market operations.

Minutes later, China cut benchmark lending rates by the same margin at the monthly fixing to their historic lows.

The one-year loan prime rate (LPR), which constitutes the benchmark for the most advantageous rates that banks can offer to businesses and households, was lowered to 3.35 per cent from 3.45 per cent previously, while the five-year LPR, the benchmark for mortgage loans, was reduced to 3.85 per cent from 3.95 per cent.

BNP Paribas head of Greater China FX and rates strategy Wang Ju said that rising expectations for the US Federal Reserve to start cutting interest rates also gave the PBOC room to manoeuvre its monetary easing.

The official Xinhua news agency cited unnamed sources close to the PBOC as saying the “decisive” rate cut showed its determination to bolster the recovery, and it was in response to the plenum’s aims to achieve 2024’s growth target.

The PBOC also made adjustments to its lending programme, saying collateral requirements for its medium-term lending facility loans will be lowered from July.

That, analysts said, means banks would need to hold less longer-term bonds for collateral needs and could sell or trade more, helping the central bank with its mission to put a floor under longer-term yields, rein in a bubble in bonds and get a steeper yield curve.

Following the rate cuts, China’s renminbi dropped to a near two-week low of 7.2750 per US dollar, before paring some losses.

“The fact that PBOC didn’t wait for the Fed to cut first indicates that the government recognises the downward pressure on China’s economy,” said Pinpoint Asset Management president and chief economist Zhang Zhiwei.

He expects more rate reductions in China after the Fed enters its rate-cut cycle.

The PBOC said in a statement that China’s rate cuts are aimed at “strengthening counter-cyclical adjustments to better support the real economy”.

The announcement also comes after the PBOC said it would revamp its monetary policy transmission channel.

PBOC governor Pan Gongsheng said in June that the seven-day reverse repo basically serves the function of the main policy rate.

“This is also a reflection of the improvement of the market-oriented interest rate mechanism,” Xinhua quoted the source as saying. REUTERS