China’s Central Bank Eases Towards And End To Easing

AS EXPECTED, THE People’s Bank of China (PBOC) has made a modest reduction to the amount of cash that banks must hold in reserve in an effort to boost lending to small businesses.

The central bank will cut the reserve requirement ratio by half a percentage point, effective from July 15, taking the requirement to 12% for large banks, 10% for smaller banks and 5.5% for rural commercial banks.

The easing will inject around 1 trillion yuan ($154 billion) of long-term liquidity into the economy. It may also be a sign of concern that the recovery is faltering.

Rising commodities prices and supply chain interruptions are increasing input costs for manufacturers while local lockdowns to counter occasional Covid-19 outbreaks and still-subdued consumer spending have hit the services sector.

Second-quarter GDP figures due next week may confirm that. Consensus forecasts are for 8% year-on-year growth, down from the first quarter’s 18.3% growth, although the comparison means little because the first quarter last year was the first to be hit by the pandemic and contracted 6.8%.

As first into the pandemic, China has been first into recovery with the PBOC leading its peers in scaling back stimulus and now starting to tighten monetary policy, albeit ever so slightly and even while insisting there has been no change of stance.

China’s Cautious Tightening

This Bystander has been pulling together the threads to make sense of the latest rise in interest rates announced by the People’s Bank of China today. The 25 basis points increases take the benchmark one-year deposit rate to 3.25% from Wednesday and the one-year loan rate to 6.31%. They are the fourth step-rise in rates since the central bank started raising them last August.

We are not so much surprised by them happening; we have long said we expect the gradual mopping up of the excess liquidity that has contributed to the economy overheating to continue deep into this year through rate rises,  increases in banks’ capital reserve requirements and the arm-twisting of the banks and their big state-owned-enterprise customers known as administrative guidance. China, unlike the other large economies in the developed world, is in the happy position of being able to tighten its monetary policy into strong growth.

We are, though, surprised by the timing, though we should be getting used to these holiday surprises. There had been some evidence that the priority concern for Beijing’s policymakers was swinging away from inflation towards slowing growth–or, at least, that they had become a double priority. For one, the People’s Bank of China had subtly changed the wording used at its quarterly conferences about its monetary stance from bringing credit growth to normal levels, the formulation used in Q4 last year, to managing liquidity efficiently, Q1’s more dovish version.

This and comments in a similar vein from senior officials suggested that they believed the economy was on track to slow more rapidly than they had expected, particularly in the second half of the year, though we remain firm in our conviction that GDP will exceed the official goal of 8% growth for the year; certainly there has been more restraint in money and credit growth so far this year than might have been expected (spot the aching arms), even though inflation has persisted for longer and at higher levels than policymakers had hoped. Next week’s consumer price inflation figures for March will confirm that, we assume; a headline year-on-year inflation rate of 5.2% is the consensus forecast of private economists. A raise in interest rates now will keep real interest rates positive, if still lagging the growth rate of the economy overall, which will mitigate their effect on deflecting consumers from putting their money into fixed assets.

Policymakers sound confident that inflation will be tamed, or at least the tiger, to use Prime Minister Wen Jiabao’s analogy, will be back in its cage, albeit pacing, by the second half of this year. Yet they will certainly have become more nervous about the global economy, particularly rising energy and commodity prices as a result of the unrest in the Middle East, which looks set to roll on and on. Nor does the problem of hot money inflows ease. Hence more caution in Beijing with an already cautious tightening.