4 Things You Need to Know About China’s Rate Cut

As my buddy Pip Diddy briefly discussed in his Asian Session Forex Recap yesterday, China’s central bank dropped a bombshell on the markets by announcing an interest rate cut over the weekend. What could this mean for the Chinese economy and market risk sentiment? Here are a few things you need to know about the announcement:

1. Economic experts say China definitely had this coming.

forex predictionIt’s no secret that economists have been getting increasingly worried about the slowdown in the Chinese economy, and the fact that the People’s Bank of China (PBOC) made their surprise rate cut announcement following the bleak CPI release confirms that policymakers have also become concerned about growth prospects. After all, the latest numbers from China don’t exactly paint a pretty picture, as the economy barely achieved the government’s 7% growth target and has just printed a weaker-than-expected annual CPI reading of 1.5%.

Besides, the PBOC has been on an easing spree for quite some time, as they’ve cut interest rates THRICE in the past six months. Aside from that, the central bank has lowered the reserve ratio requirement (RRR) TWICE this year and has also thrown in a few reductions in deposit rates as well. And that’s not all… Word through Wall Street is that PBOC policymakers are starting to discuss potential bond purchases, too!

2. Chinese officials say that it’s more about reform rather than easing.

Just as in their previous RRR cut announcement back in April, PBOC officials were quick to clarify that their interest rate cut isn’t a quantitative easing move but rather an effort to achieve investment reform. Say what?!

According to PBOC Chief Economist Jun Ma, QE involves using a set of unconventional policy measures only when interest rates are close to zero and the economy is facing a recession. He’s saying that the reduction in benchmark rates is aimed at putting downside pressure on nominal interest rates in order to stabilize investment growth. All I’m saying is that you can put lipstick on a pig but at the end of the day, it’s still a pig!

3. Investors think it’s good news.

Whether it’s really about investment reform or actual policy easing, investors seemed to take the Chinese interest rate cut positively, allowing Asian stocks to start the trading week on a good note. Equity indices in mainland China and in Hong Kong logged in strong gains for the day while Japan’s Nikkei index also took advantage of the surge in risk appetite by closing more than 1% higher on Monday.

Come to think of it, the PBOC’s 0.25% reduction in lending rates should wind up encouraging increased borrowing activity, which might support consumer spending and business investment later on. Even the Australian dollar seemed hopeful that China’s economic stimulus would eventually translate to stronger demand for the Land Down Under’s raw material commodity exports.

4. Analysts project that further cuts are likely.

Several forex analysts say that this isn’t the last of China’s easing moves, with some predicting that another decrease in RRR is likely to be seen before the end of the year. PBOC policymakers might even have to get creative about their stimulus efforts, as their interest rate cuts won’t yield much results if there isn’t enough demand for loans anyway.

In fact, Chinese central bank officials emphasized that they still have a wide range of conventional monetary policy tools at their disposal should the economy need more support. This suggests that policymakers will not hesitate to dole out more aid in combination with government spending reforms just to shore up economic growth.

What do you think China’s next move will be and can it continue to keep risk appetite afloat in the forex market? Don’t be shy to share your thoughts in our comments section!

 

  • ForExchange

    Hi Forex Gump,

    as you know I always follow your blog so I might add a little critic to fundamentals.

    What you wrote about investors think it is good news makes a lot of sense. Actually it is a good news and your arguments are just perfect. However what really matters is not we investors think but what price action confirms. I checked the weekly chart of S&P 500, Nikkei and DAX. It can be interesting what investors think but in the end what really matters is that all three indices are down for this week so the charts do the opposite what logic says 🙂 That is the problem with fundamentals.

    Have a great week,
    FE

    • Hi ForExchange, always great to have these discussions with you! It’s true what you say, price reaction isn’t always as straightforward to market events and these nuances usually provide good clues on how price movements could fare moving forward. For this rate cut, I think the idea has been long priced in already that by the time the PBOC acted investors went “Ah, finally!” and proceeded to price in positive economic expectations.

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