July 9, 2012
The People’s Bank of China (PBoC) surprised markets last thursday as benchmark 1-year lending and deposit rates were cut by 31 bp to 6% and by 25 bp to 3.25% respectively. At the same time, PBoC boosted interest rate liberalisation by allowing banks to provide up to 30% discount on lending rates.
The fact that this marks the second rate cut within a month is a clear sign that Q2 economic growth will come in weak, which also explains the muted market reaction: there is a growing fear that China’s economic slowdown will be much deeper than anticipated and that the authorities’ capability to provide stimulus will be more limited than in 2008. Also, it is questionable how useful monetary policy is in stimulating the economy: Both supply (banks unwilling to lend as interest margins shrink) as well as demand factors (companies unwilling/unable to invest as global demand remains weak) play a role here. Still, further loosening in the form of rate cuts and reductions in the required reserve ratio (RRR) may be on the cards for the coming months, as falling inflation brings real deposit rates back into positive territory and the RRR is still almost 5%-points higher than during 2009.
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