China surprises by lowering interest rates less than expected

The People’s Bank of China (BPC, the central bank) announced on Monday that it will keep the reference interest rate unchanged for its mortgage loans at 4.2%, a decision that has increased concern in the markets about how it will deal with the second world economy the threat of housing crisis and what you will do to restore the confidence of home buyers. The news has fallen like a jug of cold water on economists. In addition, the Chinese financial authorities have lowered the reference rate for one-year loans by 10 points. After last week the BPC surprisingly reduced the medium-term lending facility, experts expected a 15-basis-point drop in the benchmark rate for both one-year and five-year loans to be reported in the August review ( LPR), according to surveys conducted by Bloomberg.

The cut predicted by analysts has been limited to a 10 basis point drop in the one-year LPR, to 3.45%. While the reference rate at five remains unchanged. The last change in the one-year LPR occurred last June, when the central bank cut it from 3.65% to 3.55%. This indicator, established as a reference for interest rates in 2019, is used to set the price of new loans (generally for companies) and variable interest loans that are pending repayment. Its calculation is carried out based on the contributions to the prices of a series of banks —including small lenders that tend to have higher financing costs and greater exposure to non-performing loans—, and its objective is to lower the costs of borrowing and support to the “real economy”, according to Efe.

However, experts consider that this cut is not enough and that more specific and solid policies are needed for the impact to be tangible. Hui Shan, Goldman Sachs’ chief China economist, told the Financial Times that the PBOC’s decision is “quite surprising and, frankly, a bit disconcerting.” For their part, the economists at Capital Economics Julian Evans-Pritchard and Zichun Huang point out in a note that “the disappointing announcement of the lowering of the benchmark rate for credits reinforces our opinion that it is unlikely that the PBOC will adopt rate cuts much higher, which are necessary to reactivate the demand for credit”.

The Chinese authorities have come under pressure in recent months to cut interest rates with the aim of stimulating demand, after a summer plagued by bad economic news. Despite the reopening to the world after almost three years of tight controls to stop the spread of covid-19, the Chinese economy has not finished picking up the expected momentum. Growth has been weighed down by the slowdown in the real estate sector, a significant drop in exports, the risk of deflation and rising youth unemployment in urban areas. According to official data, the unemployment rate among young people between the ages of 16 and 24 residing in cities has been above 20% since April, and last week, the authorities announced that they would stop reporting it as of this month of August. .

On Friday, the central bank held a meeting on risk reduction in which Chinese banking and stock market regulators pledged to step up policy coordination to tackle local government debt problems, optimize policy credit for the real estate sector and stop the fall of the yuan. The Chinese currency has weakened sharply against the dollar since May and shows no signs of a rebound. Its value fell again this Monday, falling to a minimum of 7.3099 for a few hours.

Negative market reaction

The markets have also not reacted well to the central bank’s decision to cut just one of its benchmark lending rates. The Hong Kong Hang Seng index closed this Monday with losses of 1.82%, while the CSI 300, the reference rate of the Chinese mainland, made up of securities listed in Shanghai and Shenzhen, ended with a fall of 1. 44%.

Following the PBOC announcement, investment bank Citigroup cut its annual economic growth forecast for China to 4.7%, citing “political disappointment.” The figure is below the official target that Beijing set for itself in March, of a prudent 5%. Although the Chinese economy rebounded 4.5% year-on-year in the first quarter, it suffered a sharp slowdown in the second, when it only grew 0.8% compared to the first three months of the year.

Xu Tianchen, an economist at the Economist Intelligence Unit, believes that, given “the current situation, top leaders should urgently introduce support policies, including easing markets in large cities and committing to additional liquidity support for large property developers, to prevent confidence from sinking even more”. Real estate investment plummeted to 8.5% in the first seven months of the year, the lowest rate in all of 2023.

Hui Shan of Goldman Sachs opines that “policy makers seem to be placing a lot of importance on the smooth running of the banking system” in order to “continue reducing the financial leverage (debt) of the real estate sector”. This could result in them being constrained in applying further cuts to the LPR, unless they reduce deposit rates or the level of banks’ reserve requirements.

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