China’s central bank unexpectedly cuts rates to support economy.

China's central bank unexpectedly cuts rates to support economy.

China’s Central Bank Announces Second Interest Rate Cut to Boost Economy

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China’s central bank, the People’s Bank of China (PBOC), has unexpectedly cut key policy rates for the second time in three months. This move indicates that the authorities are taking action to boost the country’s sputtering economic recovery and address concerns such as tumbling credit growth and rising deflation risks.

In July, China’s economy faced challenges such as default risks at some housing developers and missed payments by a private wealth manager, which affected confidence in the financial markets. The PBOC’s rate cut is seen as an urgent response to stabilize consumer and business confidence before they deteriorate sharply.

Tommy Wu, senior China analyst at Commerzbank, explains, “All of these [challenges] add to the urgency that policymakers need to act fast before consumer and business confidence deteriorate sharply.”

The PBOC’s rate cut involved reducing the rate on 401 billion yuan ($55.25 billion) worth of one-year medium-term lending facility (MLF) loans to some financial institutions by 15 basis points to 2.50% from 2.65%. This cash injection aims to ensure reasonably ample liquidity in the banking system, counteracting factors such as tax payments.

The unexpected rate cut surprised market watchers, as a survey by ANBLE showed that the majority of participants predicted the central bank would leave the MLF rate unchanged. Ken Cheung, chief Asian FX strategist at Mizuho Bank, sees this rate cut as a response to support subdued credit data, as well as the struggling property sector.

“The surprising rate cut was a prompt response to support subdued credit data and China recovery (that) may unleash yuan depreciation pressure towards 7.3,” said Cheung. “In particularly, the PBOC may intend to support the medium-term credit conditions via the asymmetric cut, and opened the way for a cut to LPR, especially the 5-year LPR, to support the struggling property sector.”

The MLF rate serves as a guide to the loan prime rate (LPR), and markets typically use the medium-term policy rate as a precursor to any changes in the lending benchmarks. Therefore, this rate cut has opened the possibility of a cut in the LPR, especially the 5-year LPR, which would further support the property sector. The monthly fixing of the LPR is due next Monday, and market participants will be closely watching for any announcements.

In addition to the rate cut, the PBOC also injected 204 billion yuan through seven-day reverse repos, while simultaneously reducing borrowing costs by 10 basis points to 1.80%, down from 1.90% previously. These measures aim to stabilize the broader economy, which has shown signs of weakness recently.

China stands out among global central banks as it has loosened monetary policy to spur its stalling recovery, while other central banks have been tightening policies to combat high inflation. This divergence in monetary policies has widened the yield gap between China and other major economies, particularly the United States, putting additional pressure on the yuan and risking capital outflows.

So far this year, the yuan has lost about 5% against the dollar, making it one of the worst-performing Asian currencies. As of 0145 GMT, the yuan traded at 7.2842 per dollar, compared with the previous close of 7.2580.

The rate cut has also led to a decrease in yields on China’s 10-year government bonds, reaching the lowest level since May 2020 at 2.56%.

The PBOC’s previous rate cuts in June aimed to stabilize the broader economy, but data has shown increasing weakness since then. With this second rate cut, China’s central bank hopes to energize the economy and prevent it from further slowdown.

($1 = 7.2585 Chinese yuan)