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Further easing seen as China rate cut signals policy shift

[SHANGHAI] After months of modest stimulus actions to try to keep the world's second largest economy on track, China has fallen back on one of the strongest weapons in its arsenal - an interest rate cut - and analysts say more easing is on the way.

In the first such move in more than two years, China's central bank cut the benchmark one-year lending rate by 0.40 percentage points to 5.60 per cent and trimmed the one-year deposit rate by 0.25 percentage points to 2.75 per cent.

The change came as a surprise, sending European and Asian stock markets higher, but analysts say it will not be enough on its own to arrest China's slowing growth.

Chief Asia economist for Capital Economics Mark Williams said the announcement Friday marked a "major - and largely unanticipated - change of tack" by the People's Bank of China (PBoC), which until now had shunned an across-the-board rate cut.

Previously, the government had used what it called "targeted measures" including limited cuts in reserve requirements - the amount of funds banks must put aside - and two fund injections into banks for re-lending totalling 769.5 billion yuan (US$126 billion) to boost the economy. Those steps were billed as a "mini-stimulus".

But economic growth eased to 7.3 per cent in July-September, the worst quarter since the depths of the global crisis in early 2009, throwing into peril the government's expansion target of "around" 7.5 per cent for the full year.

"This is a clear step up in the intensity of monetary policy easing and is likely a response to the strong headwinds from the property market correction and the limited potency of previous measures," brokerage firm Nomura said.

China's economy has been slammed by a deflating property bubble and weak export growth, as well as a government crackdown on corruption.

"The Chinese economy has been under downward pressure since the beginning of this year," Premier Li Keqiang told Chinese and foreign Internet company executives the day before the government announced the rate cut.

The government's action also comes with the threat of deflation rising after the consumer price index remained stuck near a five-year low of 1.6 per cent in October, and a lukewarm reception earlier this month for a scheme allowing foreign investors greater access to mainland stocks.

"The market will likely read this as a positive signal that the Chinese government is responding to worsening private demand and rising deflation risks and is finally willing to send a strong signal," Barclays Bank said.

China's benchmark stock index, the Shanghai Composite, jumped 1.85 per cent on Monday in response to the news.

The biggest beneficiaries are state firms, which receive the lion's share of loans from China's biggest banks, and home buyers, while banks could be among the biggest losers as the rate cuts hit their margins.

Analysts said Beijing will have to further loosen monetary policy to keep the economy moving, probably through more interest rate cuts and reductions in reserve requirements.

Liu Ligang, Greater China chief economist for ANZ Bank, said that the rate cut "clearly signals that China's central bank has changed its monetary policy stance to a more accommodative one".

"In fact, the conditions for further policy easing are ripe," he said.

In the same announcement, the PBoC also took a step towards the long-cherished goal of free interest rates, allowing banks to offer deposit rates up to 20 per cent higher than the benchmark level, compared to the previous 10 per cent.

Song Yu, an economist at Beijing Gao Hua Securities Co., called it a "positive step" for financial liberalisation.

China began allowing banks to decide their own lending rates in July last year, but still sets deposit rates by administrative order.

Despite the small step towards freer rates, analysts warned using a blunt tool such as an interest rate cut to boost growth could mask bigger problems if China puts off reforms aimed at allowing domestic consumption to play a bigger role in the economy.

"Intensified policy easing, while supporting near-term growth, increases the risk of exacerbating China's weak economic fundamentals, creating bigger problems further out," Nomura said.