China rate cut signals possible stimulus for faltering economy

Central bank seeks to lower cost of short-term loans as credit growth weakens

China unexpectedly cut a key interest rate on Tuesday and announced tax breaks for businesses, as weakening credit growth added to signs a post-Covid recovery in the world’s second-largest economy is losing steam.

The People’s Bank of China cut the seven-day reverse repo rate, used to manage short-term liquidity in the banking system, in a move analysts said probably signalled more substantial monetary easing and stimulus measures to come.

Following the rate cut, the government released credit growth figures for May that analysts said fell well short of forecasts as a weak property market weighed on consumer sentiment.

China’s economy staged a comeback in the first quarter after the lifting of draconian Covid controls, but it has begun to falter in recent weeks as export growth has slowed and the real estate market has struggled to re-emerge from a long slump.

While the services sector is strong, with restaurants and other businesses reopening, factory activity is weak and construction has been constrained by the property market downturn.

The government sought to help address this on Tuesday by cutting the seven-day reverse repo rate by 10 basis points to 1.9 per cent in order to “maintain reasonably sufficient liquidity in the banking system”.

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It was the first cut in nine months to the rate, which sets the cost of seven-day lending by the central bank. Lowering the rate pulls down the cost of short-term loans and boosts liquidity in China’s financial system.

On Tuesday, the government also announced 22 measures to lower costs for companies this year, including tax breaks and measures to reduce interest rates and to channel loans to certain sectors.

Analysts believe the reverse repo rate reduction could presage cuts to the PBoC’s other policy rates — the medium-term lending facility rate (MLF) and the benchmark loan prime rate (LPR).

“We expect more monetary policy easing measures to be announced, including MLF rate and LPR cuts over the next few days,” Goldman Sachs said in a note.

New bank lending was Rmb1.36tn ($190bn) in May, well short of Rmb1.6tn forecast by a Reuters poll of analysts.

If the government wanted to stimulate a recovery in loan demand, it would need more aggressive rate cuts, said Julian Evans-Pritchard, head of China economics at Capital Economics.

But Beijing was reluctant to follow the example of central banks in developed countries, which aggressively eased monetary policy during the pandemic only to have to rapidly tighten afterwards.

“Obviously, the way to boost credit demand is to cut interest rates, but 10 basis points are not enough to have much impact on credit demand,” Evans-Pritchard said.

With demand for credit low, many analysts argue easing monetary policy on its own will do little to boost the economy.

More substantial steps could include providing developers with extra help to complete unfinished real estate projects.

While China’s consumers are sitting on large piles of savings and property prices are affordable by historical standards, many developers lack the funds to complete projects after a prolonged downturn.

“The main problem is that households don’t have confidence that developers will deliver the units that they buy. The government’s efforts should be focused on that,” said Evans-Pritchard.