Is China’s interest rate easing cycle nearing an end?

On Jan 25, 2022 28

People shop for clothing during a promotional New Year sale at a mall in Beijing on January 16. Consumer demand needs a boost and there’s scope for the government to cut taxes in support. Photo: AP

The PBOC’s latest lending rate cuts last week, the second in two months, are admittedly modest but pushing them further risks triggering inflationary pressures
With the economy slowing, however, Beijing must find less risky ways of boosting consumer demand and business confidence

One of China’s biggest challenges for 2022 is maintaining robust economic growth, but the worry is whether Beijing may be running out of road for future interest rate easing. China’s central bank cut benchmark lending rates last week for the second time in two months amid concerns about the sustainability of growth this year.

China’s economy grew by 8.1 per cent last year but growth is slowing and needs an extra lift. Both consumer demand and business confidence could do with a boost. The trouble is that China’s interest rates are already very low. The question is: just how low do they need to go before making a material difference to growth prospects this year?

Could China be in danger of relying too much on monetary reflation at the expense of domestic financial stability? The last thing Beijing should be doing is mimicking the West’s dependence on ultra-low interest rates. There are less risky ways for China to galvanise growth.

Any easing of borrowing costs would normally be welcome but the latest round of interest rate cuts by the People’s Bank of China was underwhelming. Size matters when it comes to making a monetary splash so last week’s 10-basis-point cut in the one-year loan prime rate, from 3.8 per cent to 3.7 per cent, after last December’s 5-basis-point easing will have caused little more than a ripple.

People walk past the headquarters of the People’s Bank of China in Beijing in September 2018. The latest round of interest rate cuts by the PBOC was pretty underwhelming.

Cuts of this magnitude are too small to make any real difference to bottlenecks in the economy or to stimulate more significant loan demand from consumers or businesses. Diminishing marginal returns are already having an effect with current interest rate levels so low.

The more thinly interest rate cuts are rationed out, the less effective they become. Has China reached that critical turning point where rates have started to lose traction and meaningful easing is effectively over?

Economists have likened the effect of using interest rates to stimulate demand to pulling a brick with a rubber band – it takes a long time to move and then risks hitting you smack in the face with higher inflation.

The US Federal Reserve has already learnt to its cost the dangers of over-ramping monetary expansion, combining near-zero interest rates and excessive debt monetisation for far too long.

Headline US consumer price inflation has already surged to 7 per cent in December, thanks to pandemic-fuelled supply constraints and soaring energy costs. Now there’s a bigger risk of demand-pull inflation locking in unless the Fed steps in quickly to cool things down. Whether the Fed’s longer-term median target of 2.5 per cent interest rates will be enough is still not clear.

Empty shelves are seen at a supermarket in Miami Beach, Florida, on January 13.

Headline US consumer price inflation surged to 7 per cent in December, thanks to pandemic-fuelled supply constraints and soaring energy costs.

Right now, China’s inflation fundamentals remain relatively subdued, with the headline consumer price index rising by 1.5 per cent in December. But continuing supply-side constraints and annual producer price gains running at 10.3 per cent last month underline that inflationary pressures are still lurking, which Beijing can ill-afford to ignore while it pushes interest rates even lower.

Beijing needs to spread the policy load between all four quadrants of potential stimulus by combining easy interest rates with easy credit, an easy exchange rate and easy fiscal policy all working in harmony.

Consumer and business optimism need a lot more support. Consumer confidence still seems relatively lacklustre, decreasing to 119.5 last November, well down from the recent post-Covid-19 crisis cyclical high of 127 in February 2021. Annual retail sales growth of 1.7 per cent in December is worryingly flat.

Business confidence, as measured by the National Bureau of Statistics purchasing managers’ index for manufacturing, is stuck in neutral territory at 50.3 in December, close to the 50 boundary which delineates expanding or contracting economic activity.

There’s definitely scope for the government to cut taxes to boost consumer demand, while increased spending on public infrastructure investment would be a boon to business confidence.

While there may be some scope for small interest-rate cuts, Beijing must be wary of making the domestic debt bubble and property market speculation even worse. With the Fed on the brink of tighter monetary policy, a reduced interest rate gap to the US will put pressure on the renminbi-US dollar exchange rate.

A weaker currency might be good news for China’s export growth, but it could risk opening up more trade tensions with the US at the wrong time.

Author: David Brown is the chief executive of New View Economics, SCMP