China’s first benchmark rate cut in 20 months signals ‘serious easing cycle is unfolding’

  • Some analysts say Beijing should ease policy further to finance infrastructure, as the country may have to defend a growth rate of 5 per cent in 2022
  • The LPR adjustment followed a 50-basis-point cut to the reserve requirement ratio last Wednesday and a partial cut of the relending rate a week earlier

The first cut to China’s one-year market benchmark rate in 20 months indicates the government’s determination to stabilise economic growth next year, but economists are still divided on how effective such easing measures will be as major Western countries tighten monetary policy.

Some analysts have called on Beijing to loosen purse strings further to finance infrastructure projects, as the country may have to defend a growth rate of 5 per cent in 2022.

The People’s Bank of China (PBOC) on Monday slashed the one-year loan prime rate (LPR), a weighted lending rate based on offers of 18 major banks and a de facto market benchmark, by 5 basis points to 3.8 per cent. However, the five-year LPR – which is linked to mortgage rates – remained unchanged at 4.65 per cent.

The central bank also sold 10 billion yuan (US$1.5 billion) of seven-day reverse repos and 10 billion yuan of 14-day reverse repos – both of which are frequently used as liquidity injection tools – leaving both rates unchanged at 2.2 per cent and 2.35 per cent respectively.

“There should be no doubt by now that a serious, though still restrained, easing cycle is unfolding,” Wei Yao, chief Asia economist at Societe Generale, wrote in a note.

China bounced back strongly from the initial impact of the coronavirus in early 2020, but economic momentum has slowed in recent months amid multiple headwinds, including widespread power shortages that have hurt industrial output, and high shipping costs and raw material prices have started to squeeze small producers.

The LPR adjustment followed a 50-basis-point cut to the reserve requirement ratio last Wednesday, which injected 1.2 trillion yuan of liquidity into the interbank system, and partial cut of the relending rate a week earlier.

Wei called the LPR cut premature, attributing it to Beijing’s growing concerns over gross domestic product growth (GDP).

“The measures taken so far – monetary, credit and fiscal – still do not seem enough for stabilising economic growth in coming months … Hence, we continue to expect more,” Wei said.

New economic risks, including the Omicron variant, potential “spillover” from US tapering and slowing export growth due to US trade tensions, have forced China’s top leadership to emphasise stability next year.

That means focusing on maintaining a reasonable GDP growth range, protecting market entities and the job market, stressing countercyclical measures, while front-loading policies and promoting appropriate project construction.

Wang Jun, chief economist of Zhongyuan Bank, said authorities should consider slashing the medium-term lending facility (MLF), the main rate the PBOC lends to commercial banks, if economic activity slows further in the next quarter.

“We must seize this window of opportunity, as the Fed’s rate hike is only one or two quarters away,” he said.

The US central bank has accelerated tapering and could hike rates earlier than expected to stave off rising inflation. The Bank of England raised its benchmark policy rate by 15 basis points last week.

Soochow Securities analyst Tao Chuan said Beijing’s choice to cut the LPR marked a further divergence in monetary policy from the US, and it could still slash the MLF or open market operations in the next quarter.

“We are facing huge downward pressure in the first quarter of 2022, considering the high property sales and investment base last year and marginally deteriorating job market,” Tao said. “A 5-basis-point cut of LPR is not enough.”

However, Ding Shuang, chief Greater China economist at Standard Chartered Bank, said higher consumer inflation and monetary tightening by major central banks did not warrant a cut of policy rates next year.

“A rate cut is not the right response to the problem China is facing,” he said.

“Fiscal policy is likely to do the heavy lifting, including ramping up and front-loading spending, with monetary and credit policies playing a supportive role.”

According to calculations by Ding, this year’s national budget has been significantly under-utilised, including one trillion yuan earmarked for infrastructure investment in early 2022.

Keeping the five-year LPR unchanged suggests a different approach toward the property sector and a preference for green and sustainable projects, analysts said.

The Ministry of Finance has allocated 1.4 trillion yuan of next year’s special purpose bond quota to local authorities, with proceeds to be used in nine areas, including transport infrastructure, energy, logistics, affordable housing and environmental protection.

“We’ll make sure the quota to be used to support the macroeconomy in the first quarter,” deputy minister Xu Hongcai told a media briefing last Thursday.

Author: Frank Tang, SCMP

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