Chinese Central Bank Goes against the Grain with Dovish Cuts

In sharp contrast to the hawkish stance of the world’s other leading central banks in 2022, the People’s Bank of China (PBOC) is cutting interest rates in a bid to further spur economic activity.  

On 15 August PBOC reduced the rates on two of the key instruments it employs in its open market operations, in a bid to influence interest rates in the rest of the economy.  

PBOC reduced the rate for its 7-day reverse repos by 10 basis points to 2.00%, and cut the the rate for 1-year medium-term lending facilities by 10 basis points, bringing it down to 2.75%. The move marks the second time in 2022 that PBOC has reduced the MLF rate.  

The cuts have since resulted in a drop in China’s loan prime rates (LPR’s) – the designated benchmark rates for the Chinese financial system that are based upon the rates offered by a select group of banks to their best customers.  

The LPR’s published on 22 August were 3.65% for the 1-year tenor, marking a 5-basis point fall compared to the previous month, and 4.3% for the 5-year tenor, for a 10-basis point decline.  

Source： Tradingeconomics.com – China’s 1-year Loan Prime Rate 

PBOC’s rate cuts mark a sharp contrast to the hawkish monetary policy plied by other major central banks in 2022 – chief amongst them the Federal Reserve, which has ratcheted up its target rate by 225 basis points since the start fo the year.  

A key reason for this is that China has thus far been spared the raging inflation convulsing Western economies in the wake of Covid-19. The Chinese economy has also met with easing growth as a result of a renewed round of Covid lockdowns in 2022, as well as the debt woes of top property developers.  

China’s annual inflation rate rose to 2.7% in July from 2.5% in June. While the print for July is ahead of the 2% gain in prices that is typically favoured by responsible central banks, it was still short of the consensus forecast of 2.9%, and well short of the rampant increases seen in the world’s other major economies. 

Source： Tradingeconomics.com – China’s inflation rate 

On top of comparatively moderate inflation, China also saw lending volumes ease considerably in year-on-year terms in July, in a worrying sign of easing economic activity. 

People’s Bank of China (PBOC) data indicates that new renminbi lending totalled 679 billion yuan for July, 404.2 billion yuan less than the print for the comparable period last year and well short of consensus expectations.  

Liquidity in the Chinese banking system remains ample, prompting domestic observers to impute the decline in lending levels in July to weak demand for financing on the part of both households and enterprises.  

China’s latest round of official economic data also paints a concerning picture in key areas. The manufacturing purchasing manager’s index (PMI), which is a barometer of manufacturing activity, fell 1.2 percentage points in July compared to June with a drop to 49%  

Growth in retail sales was sluggish, easing to 2.7% from 3.1%, while commercial housing sales plunged a shocking 28.8% in year-on-year terms.  

Most worrying of all was the youth unemployment rate China, which hit a record 20% in July. The print no doubt prompted strong concern amongst policymakers in Beijing, given their abiding preoccupation with the preservation of social stability.  

For these reasons the Chinese central bank and central government policymakers could continue to run against the grain of other leading economies, with even looser monetary policy measures alongside enhanced stimulus measures.