Daily Management Review

Despite Rising Yuan Risks, China Surprises With A Slight Rate Drop


Despite Rising Yuan Risks, China Surprises With A Slight Rate Drop
As part of increased efforts to boost credit demand, China lowered its benchmark lending rate for one year on Monday. However, markets were taken aback when China kept the rate for five years unchanged despite broader worries about a swiftly depreciating yuan.
Due to a deteriorating real estate slump, sluggish consumer spending, and falling credit growth, the recovery in the second-largest economy in the world has lost momentum, strengthening the need for policy stimulus from the government.
Analysts note that Beijing's options for more monetary easing are constrained by the downward pressure on the yuan because a further widening of China's rate differentials with other major countries could result in yuan selloffs and capital flight.
The five-year LPR was left at 4.20%, while the one-year LPR was reduced by 10 basis points to 3.45% from 3.55% earlier.
All 35 market observers surveyed by Reuters who follow the markets projected reductions in both rates. The average poll respondent anticipated a 15 bp cut, therefore the 10 bp reduction in the one-year rate was less than anticipated.
"Probably China limited the size and scope of rate cuts because they are concerned about downward pressure on the yuan," said Masayuki Kichikawa, chief macro strategist at Sumitomo Mitsui DS Asset Management.
"Chinese authorities care about currency market stability."
The majority of current loans in China are based on the one-year LPR, whereas mortgage rates are influenced by the five-year rate. In order to stimulate the economy, China lowered both LPRs in June.
The benchmark Shanghai Composite index and the blue-chip CSI 300 index both fell during the first trading day, while the onshore yuan softened to 7.3078 per dollar from its previous closing of 7.2855.
One of the worst performing Asian currencies this year has been the yuan, which has fallen roughly 6% against the dollar thus far.
The People's Bank of China (PBOC) unexpectedly decreased its medium-term policy rate last week, which led to the drop in the one-year LPR.
Markets frequently use the medium-term lending facility (MLF) rate as a benchmark for the LPR and as a sign of upcoming adjustments to the lending benchmarks.
According to its second-quarter monetary policy implementation report, China's central bank has also promised to maintain liquidity that is "reasonably ample" and its policy "precise and forceful" to assist the economic recovery, despite escalating headwinds.
Although several traders and analysts anticipated that the deteriorating real estate market and mounting default risks at some developers would have resulted in bigger cuts to the benchmarks, the constant five-year tenor surprised many of them.
"We interpret the status quo of five-year LPR was a signal that the Chinese banks are reluctant to cut rates at the expense of rate differential margin," said Ken Cheung, chief Asian FX strategist at Mizuho Bank.
"It flagged a problem on the effectiveness of PBOC's policy guidance pass-through into the market, and the Chinese authorities may be lacking effective tools to stimulate the property sector and economy via monetary easing."
The surprise rate result should be "negative to China growth outlook and the yuan exchange rate," Cheung continued.
In a statement released on Sunday, the central bank stated that it will coordinate financial assistance to address local government debt issues while also optimising lending rules for the real estate sector.