China ushers in new era of ‘proactive easing’ as economic recovery turns sour

A central bank move in Beijing this week is seen by economists as the starting gun for a new era of monetary policy as China’s reopening from Covid-19 slows down.

On Tuesday, the People’s Bank of China cut its seven-day reverse repo rate from 2% to 1.9% — the first cut in nine months — as the economy loses momentum and hard data begins to disappoint. Top Chinese economists at Wall Street banks saw the move as the start of much more easing to come.

“This is the first cut since August 2022 and further confirms that policymakers have shifted to proactive easing from wait-and-see,” Citi economists led by Xiangrong Yu said in a research note on Tuesday shortly after the PBOC’s announcement.

“Our thesis of timely easing is playing out, and more measures of small steps that do not have a high threshold may follow in the coming weeks,” they said, adding that the upcoming July Politburo meeting in Beijing will be closely watched for more significant measures to follow.

China’s government bonds rose in price after the latest move by the central bank, while the Chinese yuan fell to its weakest levels since November.

Citi economists pointed to soft economic numbers from China, including credit data, saying “stimulus appears to be under way with the weak readings.”

China’s new bank loans for the month of May rose 11.4% to 1.36 trillion yuan ($190 billion), missing estimates from a Reuters poll and bolstering the case for further stimulus as the economy continues to see falling industrial profits on soft demand and falling export.

Barclays economists, writing in a Tuesday note titled “Entering a rate cut cycle,” forecast China will deliver a cut every quarter until early 2024. The bank predicts a 10 basis point cut in the medium-term lending facility on Thursday, as well a cut in interest rates next week (two monetary levers that the PBOC uses).

“Over the next nine months, based on our economic analysis and reasoning, we now expect the central bank to continue its monetary policy easing cycle by a further 30bp [basis point] policy rate cut overall, 50bp RRR cut and 60-80bp mortgage rate cut for both new and existing mortgages,” Barclays economists led by Jian Chang said in a note.

Goldman Sachs economists including Hui Shan said the firm expects the central bank to cut its medium-term lending facility rate on Thursday and its prime rate by 10 basis points next week. China’s central bank controls the one-year lending and deposit rates, which affect borrowing costs for banks, businesses and individuals across the country.

Noting that the PBOC has never cut policy rates and the reserve requirement ratio in the same month before, Goldman Sachs economists expect a full RRR cut to be delivered in the third quarter of this year. The reserve requirement ratio refers to how much money banks must keep on hand as a proportion of their total deposits.

Goldman Sachs also expects the PBOC to deliver another 25 basis point RRR cut in the third quarter of this year, its economists said, adding that the firm expects another cut in the final quarter as well.

“Slow activity growth, potentially weak credit extensions and low confidence are the reasons behind this cut, in our view,” they said.

Mizuho Bank’s head of finance and strategy for Asia, Vishnu Varathan, argued that the latest actions by China’s central bank “don’t cut it.”

“Markets were rightly unimpressed as credit data details suggest a worrying shortfall in private sector confidence that is likely to reduce ongoing stimulus,” he said.

He predicted a more substantial plan would be needed – at the risk of overreaching and damaging the stability of the economy.

“Barring a more comprehensive stimulus plan that could necessarily put financial stability at risk, PBOC rate cuts don’t seem to cut it,” Varathan said.

Societe Generale economists also said, “much more easing is needed, especially fiscal policy supported by central government funding.”

“However, the trickle-down method of easing – favored by Chinese policymakers – may not be well-suited to contain the growing downward pressure in the economy,” SocGen economists said.