China Maintains Benchmark Lending Rates but Cuts Likely Soon: Analysts

‘We anticipate 20 basis-points of cuts by the end of quarter-one next year.’
China Maintains Benchmark Lending Rates but Cuts Likely Soon: Analysts
People walk past a branch of the Bank of China in Beijing on Sept. 11, 2009. (Peter Parks/AFP via Getty Images)
Indrajit Basu

In an effort to maintain a delicate balancing act between pushing economic recovery and limiting further depreciation of the yuan, China left benchmark lending rates (LPR) unchanged at a monthly fixing on Monday.

But even as this was expected by the market, according to analysts at Capital Economics, the central bank, The People’s Bank of China will be forced to slash rates sooner rather than later, owing to the weakening momentum of the world’s second largest economy.

“Policymakers may want more time to assess the impact [of the recent policy measures] before they make further changes to the benchmark rate,” a Capital Economics note accessed by The Epoch Times said.

“[But] The big picture is that, with the economic momentum weak, rate reductions will come before long. We anticipate 20 basis-points [0.2 percent] of cuts by the end of quarter-one next year,” the note added.

According to the National Interbank Funding Center, the one-year loan prime rate (LPR), which is determined by the market and serves as a benchmark for determining interest rates, was set at 3.45 percent on Monday, and did not move from the previous month’s level.

The five-year LPR, which is used by many lenders as a basis for determining the interest rates they provide for mortgages, remained constant as well from the previous rate of 4.2 percent.

Reuters reported on Monday that the market was expecting this status quo given that the yuan is under pressure and continues to remain weak despite recent policy measures to hold the currency steady, and the patchy economic recovery.
Twenty-six market experts were polled last week and they were unanimous in their expectation that both the one-year LPR and the five-year tenor would remain unchanged.

Reportedly, The People’s Bank of China last week also requested some lenders to cap their interest rates, highlighting the authorities’ intention to keep borrowing costs low in the slowing economy, even as the central and local governments issue more debt to fund infrastructure and consumer sectors.

The central bank instructed banks to maintain somewhat stable interest rates ahead of its medium-term loan policy announced on Monday.

In October, China’s yuan-denominated loans increased by 738.4 billion yuan ($102.86 billion), considerably above market expectations of 600 billion–650 billion yuan, according to the state-run Global Times.

Faltering Momentum

Over the past four months, as China’s post-pandemic recovery faded quickly, Beijing adopted a host of policy steps to jumpstart a flagging economy.

However, those measures hardly proved effective, prompting many to question if they can meet Beijing’s official GDP growth target of 5 percent this year, the lowest in decades.

While numbers released by the National Bureau of Statistics last week revealed a minor upswing in industrial output and retail sales in October, China edged back into disinflation as consumer demand continued to weaken and producer prices fell.

With property sales continuing to fall and investment in real estate plummeting, analysts also feared that the permeating risks of the real estate crisis will spread to other sectors of China’s economy.

“The prolonged property market downturn is resulting in adverse spillover effects to other nonfinancial corporate sectors through direct and indirect channels, [while] most sectors will face [the] effects for foreseeable future,” Moody’s said in a client note last week.

The Yuan Factor

Yet, while China’s property industry and its economy require additional policy support, analysts believe that an increase in monetary easing will put unwanted downward pressure on the Chinese currency as well.
Although the yuan has recovered some of its year-to-date losses—it lost more than 6 percent against the dollar at one point in September—more rate cuts would make the yield gap with the United States wider, which could cause the yuan to fall in value and capital to leave the country.
After peaking at 244 basis points in early August, the spread between the China 10-year Government Bond yield and the U.S. Treasury 10-year yield is still sitting wide at 178 basis points as of Monday, implying that the 10-year Chinese government bond yield is lower—and hence, less attractive—than the 10-year U.S. Treasury bond yield.

This also means that “outflow pressures will persist amid unfavorable interest rate spread,” according to a Goldman Sachs note published last week.

However, despite the negative rate spread, “top policymakers continue to prioritize [on the yuan] stability,” due to “the depreciation pressures on the currency,” said the note.

“We expect the yuan to dollar exchange rate [thus] to be broadly stable at 7.30 [yuan to a dollar] in the next few months,” the note added.