With the US Federal Reserve signalling that it might cut interest rates this year, the question arises whether China’s central bank would follow suit. This matters since the Sino-US trade war is increasing uncertainty over the outlook for global economic growth, including in China and the US.
Which rates would the PBoC target?
However, the answer is iffy as China is in a prolonged transformation of its interest-rate regime. While a decade ago, a rate cut meant simply cutting the benchmark commercial bank deposit and lending rates, there are many more interest rates at the disposal of the People’s Bank of China (PBoC) now.
As and when the Fed cuts rates, and assuming China’s growth remains feeble under the shadow of the trade war, the PBoC will likely follow suit and cut quasi policy rates such as the reverse repo rate, the medium-term lending facility rate and the standing lending facility rate.
It will likely not touch the benchmark lending rate as any such move would mean a system-wide change. Since the lending facilities are targeted tools, cutting their interest rates will only mean selective easing. Even as Beijing has shelved, arguably temporarily, its deleveraging campaign, it has insisted on implementing targeted easing only rather than going for a wholesale bailout with a massive liquidity injection.
Targeted PBoC easing to remain in place
Beijing is expected to promote 1) the prime lending rate, which is decided by the commercial banks rather than by the PBoC, to replace the benchmark lending rate, and 2) the 7-day interbank deposit rate (DR007) as the target policy rate in its interest rate corridor framework, which is still experimental.
The bank reserve requirement ratio (RRR) will likely remain a liquidity management tool, but no longer a macroeconomic policy instrument as it used to be. The PBoC is also expected to cut the RRR by another 100bp in coming months, especially when the Fed cuts rates.
All this means that targeted easing will likely remain in place on the back of potential Fed rate cuts. The overall liquidity environment should remain benign for Chinese assets in coming months, giving Chinese bond yields room to fall further.
The onshore yield spread has rolled over (se exhibit 1) due to the PBoC’s benign liquidity policy, the outlook for moderate GDP growth, and easing concerns over credit risk. The spread should narrow further if, as we expect, the economy continues to stabilise in the absence of any inflationary pressures.
Exhibit 1: China’s corporate bond spread over government bonds*
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