China resorts to interest rate cuts as data shows 'alarming' slowdown

China’s central bank unexpectedly cut its key interest rates as it ramps up support for an economy weighed by Covid lockdowns and a deepening property downturn. 

Bond yields slumped after the People’s Bank of China lowered the rate on its one-year policy loans by 10 basis points to 2.75% and the seven-day reverse repo rate to 2% from 2.1%. All 20 economists polled by Bloomberg had forecast the rate on the one-year medium-term lending facility would be left unchanged. 

 

The need for additional stimulus was underscored shortly after the surprise central bank move, when official data showed retail, investment and industrial production numbers for July all missed economists’ estimates. 

• Industrial production rose 3.8% from a year ago, the National Bureau of Statistics said, lower than June’s 3.9% and missing economists’ forecast of a 4.3% increase
• Retail sales grew at a slower-than-expected pace of 2.7%
• Fixed-asset investment gained 5.7% in the first seven months of the year, also worse than the 6.2% projected by economists
• The surveyed jobless rate fell to 5.4% from 5.5%

“July’s economic data is very alarming,” said Raymond Yeung, Greater China economist at Australia & New Zealand Banking Group Ltd. “The Covid Zero policy continues to hit the service sector and dampen household consumption.”

China’s 10-year government bond yield slid five basis points to 2.675%, the lowest level since May 2020. The offshore yuan extended losses, falling 0.3% to 6.7607 per dollar. Stocks were volatile in the morning session. The benchmark CSI 300 Index was little changed as of 10:11 a.m. in Shanghai, after rising as much as 0.7% following the PBOC’s rate cuts.

The nation’s commitment to Covid Zero has made it tough to sustain any hard-won economic progress, as the threat of repeated restrictions and re-openings continues to loom. August saw a surge in cases in the resort island of Hainan, where authorities have locked down holidaymakers, suspended flights and shut businesses to contain infections. 

While the rate cut was small, “it’s more of a signaling effect” showing authorities are prepared to act, said Zhang Zhiwei, chief economist at Pinpoint Asset Management Ltd. “In terms of the size of this action, it’s quite limited. In order to turn around the market expectation and break the downward spiral, they need to do a lot more.”

The central bank at the same time withdrew liquidity from the banking system by issuing 400 billion yuan of MLF funds, only partially rolling over the 600 billion yuan of loans maturing this week. That was in line with economists’ forecasts.

What Bloomberg Economics Says...

The People’s Bank of China’s decision to cut its key one-year interest rate came a little sooner than we expected but the urgency is understandable -- the plunge in July credit was alarming and sent a powerful message that the economy needs more support to deal with a deepening property slump and Covid-Zero restrictions.

David Qu, China economist

The PBOC’s move follows Friday’s weaker-than-expected credit growth data for July as new loans and corporate bond issuance slowed. The figures raise the risks of a liquidity trap where monetary easing is failing to spur lending in the economy.

“The dominating downside risk for growth and weak credit data prompted the PBOC to lower the policy rates,” said Ken Cheung, chief Asian FX strategist at Mizuho Bank Ltd.  

The cut widens the divergence between the PBOC’s easing stance and other major central banks that are tightening monetary policy to curb soaring inflation. That’s raising risks for the yuan as capital outflow pressures increase. 

It also comes a surprise as the PBOC recently warned against the risk of rising inflation, even though domestic demand still remains soft, keeping overall price pressures in check for now.

The rate reduction underscores the severity of growth challenges. China’s top leaders vowed last month to achieve “the best outcome” possible for economic growth this year while sticking to a strict Covid Zero policy, and downplayed the official target of around 5.5% growth. Economists polled by Bloomberg forecast the economy to expand only 3.8% this year.