Aidan Yao, senior emerging market economist at AXA Investment Managers (AXA IM), comments on the People’s Bank of China (PBoC) announcement of a “twin” cut to the required rate of return (RRR) and interest rates over the weekend.
The PBoC announced a 25 basis point cut to the benchmark policy rates, taking the one-year lending rate to 4.85% and deposit rate to 2%. In addition, it also lowered the RRR, by 50 basis points for commercial banks that meet the requirements on rural, and small and medium-sized enterprise lending, and by 300 basis points for selective finance companies. While the RRR cut was coined as “targeted” easing, Aidan believes most commercial banks will qualify for the reduction. Hence, the amount of liquidity released will not be too different from a standard cross-the-board RRR cut of around 650bn renminbi (RMB).
This is the first combined policy easing since the global financial crisis (GFC). Both the timing and scale of the move were a surprise to us, and we think there is little doubt that the action was triggered by the recent plunge in the equity market. We expect the front-loading of policy easing to solidify the nascent economic recovery, and alleviate risks of wider contagion from the equity market selloff. Despite the policy easing, declines in the equity market continued today, driven again by forced selling from leveraged-position closeouts. We think the latest policy easing has demonstrated a very strong official intention to generate a “soft-landing” in the equity market. In that regard, should the selloff continue at the current pace, further market support measures could be announced in the coming days.
Weak economy justifies the easing, but timing and scale are surprising. Despite some signs of growth bottoming out, make no mistake I believe China’s overall economic backdrop remains weak. The government still faces difficulties to hit its growth target (we think Q2 growth will fall short of 7%), while the PBoC remains concerned about lingering deflation and elevated funding costs. In that regard, further policy easing is clearly justified. However, we would have thought that, given the rapid easing already delivered, the PBoC would want to wait to see how self-sustaining the recent recovery is, before taking further actions in H2.