China makes surprise rate cut as economic recovery loses steam

By Laura He, CNN

Hong Kong (CNN) — China’s central bank on Tuesday made a surprise cut to one of its key lending rates in a bid to shore up sputtering growth in the world’s second largest economy.

The cut to the 7-day reverse repo rate — the first since August last year — will boost liquidity in the banking system and make short term loans cheaper. The rate will drop to 1.9% from 2%, according to the People’s Bank of China.

The amount of lending affected is small, but the move is significant as it signals that the PBOC is likely to cut several other key interest rates later this month, analysts say.

The rate cut reveals “growing concerns among policymakers” about the health of China’s recovery, Capital Economics analysts said on Tuesday.

It is likely to be followed by similar reductions to a medium-term lending rate, and the benchmark Loan Prime Rate (LPR) on Thursday and next Tuesday respectively, given that all three rates typically move in tandem, they added. The last time China slashed its LPR was also in August last year.

“The … rate cut came earlier and sharper than our and market expectations, highlighting the sense of urgency to alleviate economic momentum and business confidence,” said Becky Liu, head of China macro strategy for Standard Chartered Bank.

In March, the PBOC cut its reserve requirement ratio — which determines the amount of money that banks must keep in reserve, rather than lend out — by 0.25 percentage points, in an effort to keep money flowing through the financial system and prop up the economy. That rate cut also came as a surprise and followed a week of turmoil in global financial markets triggered by the failure of some regional US banks.

‘Imminent’ policy pivot?

Multiple indicators show that China’s recovery is waning following an initial burst of activity in the first few months of this year after the lifting of Covid-19 restrictions.

Deflationary risks are hanging over the economy. The Chinese producer price index fell 4.6% in May, the biggest decline in seven years, according to government statistics released last week. The consumer price index edged up 0.2% in May from a year ago. In April, the CPI increased by just 0.1%.

The low inflation levels are in sharp contrast to rising prices in other major economies around the world, suggesting weakness in China’s domestic demand.

Exports fell 7.5% in May from a year earlier, the biggest decline since January, and imports contracted further.

The country’s official manufacturing PMI, a gauge of factory activity among big, state-owned firms, slid further into contraction territory in May.

Youth unemployment rate, meanwhile, surged to a historic high of 20.4% in April, highlighting the pressure the economy is facing to absorb new workers.

“China’s growth has been losing momentum amid deteriorating confidence,” said Zhaopeng Xing and Betty Wang, analysts for ANZ Research, in a research note on Tuesday.

Moreover, heavily indebted households are attempting to save up to repay loans instead of spending, they said. Local governments are also facing mounting debt repayment pressure this year.

The authorities appear increasingly worried.

Yi Gang, governor of the PBOC, said last weekend that “counter-cyclical adjustment” will be strengthened.

In the language of China’s policymakers, that implies a bias towards easing monetary policy, said Larry Hu, chief China economist for Macquarie Group. “Governor Yi sent a clear signal that further policy support would be forthcoming in the near term.”

The “policy turning point is imminent,” he added.

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