On 21 November 2014, The People’s Bank of China (PBoC) took markets by surprise by announcing a cut in the 1-year benchmark lending rate by 0.4% to 5.6% and the 1-year benchmark deposit rate by 0.25% to 2.75%, effective from November 22. Meanwhile, the PBoC raised the deposit rate ceiling from 1.1x to 1.2x the benchmark rate.
Exhibit 1 : PBoC rate cut : 1-year lending and deposit rate.
A rate cut was not expected so soon after liquidity measures for banks which themselves constituted monetary easing
This rate cut comes as a surprise as the PBoC recently undertook a mini-stimulus via an unconventional liquidity tool, in order to help counter the effects of slowing economic growth. The magnitude of these policy measures was reckoned to be the equivalent of a 75bp cut in the reserve requirement ratio:
• Starting in June 2013 the PBoC instigated a Standard Lending Facility (SLF) to provide short-term liquidity (the tool is similar to the discount window at the Federal Reserve and Marginal Lending Facility (MLF) at the ECB) to China’s banks.
• The SLF was expanded in January 2014 to supply short-term liquidity to small and medium-sized banks in 10 provinces
• In September and October 2014 the PBoC undertook a Medium-Term Lending Facility operation to provide liquidity to commerical banks
So why cut rates then ?
In our view the PBoC’s recent measures have not actually had a large effect on the financing costs for small and medium-sized companies in China. SHIBOR rates have been quite stable since September. As a result, the PBoC has had to cut rates to support the economy (the latest economic data was quite disappointing). A cut in official interest rates is rare in China, as unlike open market operations or other monetary tools, an interest cut needs approval from the State Council. This rate cut was larger than the usual 27bp, which shows the willingness of the government to support financing that is, according to the PBoC statement, “difficult” and “expensive” at the moment.
In the meantime this will create more competition between banks. We see it as a good way of preparing liberalisation of the banking system, which is also needed to ensure further financial reforms.