China surprises with modest rate cut amid growing yuan risks
China Cuts Benchmark Lending Rate to Stimulate Credit Demand
The recovery in China’s economy has lost steam due to a worsening property slump, weak consumer spending, and tumbling credit growth. To address these concerns, China has cut its one-year benchmark lending rate on Monday. However, the surprise move was keeping the five-year rate unchanged, which raised concerns about the rapidly weakening currency.
Analysts believe that the downward pressure on the yuan limits China’s ability to implement deeper monetary easing. A further widening of China’s yield differentials with other major economies could trigger yuan selloffs and capital flight.
The one-year loan prime rate (LPR) has been lowered by 10 basis points to 3.45% from 3.55% previously, while the five-year LPR remains at 4.20%.
In a Reuters poll of 35 market watchers, all participants predicted cuts to both rates. However, the 10 basis point cut in the one-year rate was smaller than the expected 15 basis point cut.
“Probably China limited the size and scope of rate cuts because they are concerned about downward pressure on the yuan,” said Masayuki Kichikawa, chief macro strategist at Sumitomo Mitsui DS Asset Management.
“Chinese authorities care about currency market stability.”
Most new and outstanding loans in China are based on the one-year LPR, while the five-year rate influences the pricing of mortgages. China cut both LPRs in June to boost the economy.
The onshore yuan eased in early trade to 7.3078 per dollar, compared with the previous close of 7.2855, while benchmark Shanghai Composite index and the blue-chip CSI 300 index also declined.
The yuan has lost nearly 6% against the dollar so far this year, making it one of the worst performing Asian currencies.
The reduction in the one-year LPR comes after the People’s Bank of China (PBOC) unexpectedly lowered its medium-term policy rate last week.
The medium-term lending facility (MLF) rate serves as a guide to the LPR and is widely read by markets as a precursor to future changes to the lending benchmarks.
China’s central bank has also pledged to keep liquidity reasonably ample and its policy “precise and forceful” to support the economic recovery, amid rising headwinds, according to its second-quarter monetary policy implementation report.
However, the steady five-year tenor caught many traders and analysts off guard. Some expected deeper cuts to the benchmarks due to the troubled property sector and rising default risks at some developers.
“We interpret the status quo of the five-year LPR as a signal that the Chinese banks are reluctant to cut rates at the expense of rate differential margin,” said Ken Cheung, chief Asian FX strategist at Mizuho Bank.
“It flagged a problem on the effectiveness of PBOC’s policy guidance pass-through into the market, and the Chinese authorities may be lacking effective tools to stimulate the property sector and economy via monetary easing.”
Cheung added that the unexpected rate outcome should be “negative to China’s growth outlook and the yuan exchange rate.”
The central bank stated that it will optimize credit policies for the property sector and coordinate financial support to resolve local government debt problems, according to a statement on Sunday.
(Reporting by Winni Zhou and Tom WestbrookAdditional reporting by Kevin BucklandEditing by Sam Holmes)
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