China disappoints and puzzles with latest move on lending rates

SHANGHAI – Chinese banks kept a key interest rate that guides mortgages on hold, a surprise move that sowed confusion over the country’s approach to stemming its property slump.

The five-year loan prime rate (LPR) was unexpectedly held steady at 4.2 per cent on Monday, according to data from the People’s Bank of China (PBOC). Most economists had expected the rate to be cut by 15 basis points following a similar reduction last week to an important central bank policy loan rate. That was seen as a precursor for a cut to the five-year LPR.

The one-year LPR was lowered by 10 basis points to 3.45 per cent from 3.55 per cent, a smaller cut than what most economists surveyed by Bloomberg had expected.

“The decision to keep the five-year unchanged is puzzling,” said Mr Zhang Zhiwei, chief economist at Pinpoint Asset Management. “It is not clear how to interpret this decision and the cut last week.”

China’s blue-chip index and Hong Kong’s Hang Seng Index both dropped to the lowest level since late November 2022, underwhelmed by the measures.

The CSI 300 index slid 1.4 per cent on Monday, while the Hang Seng Index fell 1.8 per cent.

The government has signalled more urgency in shoring up growth for the world’s second-largest economy as borrowing demand slumps, deflation pressures take hold and confidence struggles to recover. Days after last week’s shock cut to the PBOC’s medium-term lending facility (MLF) rate, the central bank and financial regulators met bank executives and told lenders again to boost loans. That all culminated in expectations on Monday that the loan prime rates would also be reduced. While the rates are determined by the banks, the PBOC has influence over the monthly setting.

The rates are based on the interest rates that 18 banks offer their best customers, and they are quoted as a spread over the central bank’s one-year policy rate.

Weak data recently has prompted several banks to cut their growth forecasts for the year to below 5 per cent, implying the government may miss a growth target set earlier in 2023. Investors are also concerned about contagion risks following a liquidity crisis at a major shadow bank.

Several analysts suggested that Chinese banks may have been limited in their ability to lower their prime rates even with last week’s policy rate cut, which was intended to reduce bank financing costs and encourage them to lend more.

Chinese banks have experienced narrowing interest margins and lower profitability in recent years due to fiercer competition in the credit market and a decline in lending rates since the pandemic, the PBOC said in a special section of its quarterly report published last week. Banks need to maintain “reasonable profits and net interest margins” so that they can serve the real economy and prevent financial risks, the PBOC said.

Lenders may have also been constrained because average new mortgage rates are at record lows. The average fell to 4.11 per cent in June, according to last week’s PBOC report.

In 2022, the five-year LPR was cut by a total of 35 basis points – more than the 20-basis point reductions seen in the MLF rate, and deeper than the 15 basis points’ worth of trims to the one-year LPR.

“The lack of ability to lower the LPR rate, which is determined by banks, even with such a strong MLF rate cut suggests more measures to lower banks’ cost of liabilities will become more urgent,” said Ms Becky Liu, head of China macro strategy at Standard Chartered.

She suggested more actions may be forthcoming, including some combination of a cut to the reserve requirement ratio for banks, reduced deposit rates and trims to relending rates.

Monday’s actions also send a signal “that authorities don’t want the property market to overheat”, said Mr Bruce Pang, chief economist and head of research for greater China at Jones Lang LaSalle.

“There has been speculation on whether the government will completely let loose property policies after the Politburo meeting omitted the pledge that housing is not for speculation,” he said, referring to a meeting held in July by the Communist Party’s top decision-making body. The absence of that slogan, a signature of President Xi Jinping, fuelled speculation that some tough restrictions on property would be reversed.

“The signal now is that there will still be policy controls on the property sector, just that they will be optimised,” Mr Pang said, adding that the authorities had introduced a mechanism for lowering new mortgage rates, lessening the need to adjust the five-year LPR.

Policymakers may also have judged that cutting the mortgage reference rate “is not the most effective tool”, said Ms Frances Cheung, rates strategist at OCBC.

“Either that’s it, or the regulators are mulling over something more substantial in supporting the property sector,” she added. BLOOMBERG