People’s Bank of China Disappoints Analysts With Rate Cut

People’s Bank of China Disappoints Analysts With Rate Cut
A pedestrian walks past the People's Bank of China, also known as the China's Central Bank, in central Beijing on Aug. 9, 2007. (Teh Eng Koon/AFP via Getty Images)
Indrajit Basu

After the People’s Bank of China (PBC) on Monday decided not to cut an important interest rate that influences mortgages, disappointed analysts and economists said restoring faith in China’s troubled real estate sector, which has dragged down the world’s second-largest economy, will be difficult.

In a smaller-than-anticipated move, the PBC lowered its one-year prime rate (LPR) for loans with a term of one year from 3.55 percent to 3.45 percent, whereas the benchmark rate used to set mortgage rates (the five-year LPR) has stayed intact at 4.20 percent. The consensus among experts was for a reduction of 15 basis points (bps) in both rates.

“The five-year rate is the reference rate for banks for mortgage lending, but PBC has not reduced that and reduced the one-year rate. At a time when China wants to support its economic recovery, the one-year rate reduction is a disappointment,” Raymond Yeung, chief economist of Greater China at the ANZ Group, told The Epoch Times.

According to Mr. Yeung, the LPR is the standard against which commercial banks base their interest rates for lending to consumers and businesses. Most loans with terms of one year or less are influenced by the one-year rate, whereas mortgages and other longer-term loans are influenced by the five-year rate.

Those taking out loans or making interest payments, hence, would benefit from a reduced LPR but not businesses and the broad economy, since the existing mortgage interest rate at 4.8 percent is much higher than the interest rate for new mortgages.

Policymakers had hinted in July that they would direct banks to adjust and lower interest rates on current mortgages, Mr. Yeung added.

According to economists, confidence has emerged as an essential element of China’s economic recovery, and the disappointing LPR cut would not only undermine confidence but could “even backfire if market participants interpret these easing measures as policymakers’ unwillingness to deliver even moderate policy stimulus,” said Goldman Sachs in a note.

Considering the deterioration of property indicators and weak activity growth, more policy easing is needed, added the note.

On monetary policy, Goldman Sachs feels that the PBC should cut the reverse repo rate (RRR) by 25 bps and the seven-day open market operations (OMO) rate in the second half of the financial year.

The RRR is the interest rate at which a country’s central bank borrows money from domestic commercial banks. OMO refers to a central bank’s open market purchases and sales of government securities when it needs to infuse liquidity into the monetary system. During times of inflation or deflation, a central bank employs both tools for managing the money supply.

China is on the cusp of deflation as its economy continues deteriorating despite prior forecasts of a post-COVID resurgence. According to a July report from the National Bureau of Statistics, Chinese producer prices decreased 4.6 percent year on year in May, marking the eighth straight decline and the largest drop since 2016.

Meanwhile, consumer prices climbed at 0.2 percent year on year, lower than economists’ projections of 0.3 percent and another indicator of weak demand. As a result, deflation—a situation where prices fall and economic activity contracts—is a looming concern in China.

Goldman Sachs was also expecting a further reduction in existing mortgage rates and major easing measures in top-tier cities—including reducing mortgage rates, lowering down payment requirements, and lifting purchase and resale restrictions—to support the real estate markets.

Nevertheless, the smaller-than-expected LPR cut would help ease pressures on banks’ net interest margins (NIM), which could be one of the primary reasons for the smaller-than-expected LPR cut, according to the Goldman Sachs report.

China also had to restrict the extent and scope of rate reduction due to the yuan’s depreciation, said a note by Sumitomo Mitsui DS Asset Management.

On Monday, China’s struggling economy dragged the yuan to near its lowest level of 2023, trading close to 7.28 to the dollar and falling roughly 6 percent year-to-date (at the time of reporting). That made the yuan one of the worst-performing Asian currencies this year.

Nevertheless, according to Goldman Sachs, protecting banks’ net interest margins (NIMs) appeared to be the main motivation behind the smaller-than-expected LPR cuts, and by protecting banks’ NIMs on new loans whose interest rates are linked to LPRs, policymakers can follow up with more property-easing measures such as guiding interest rates for existing mortgages.

“Better NIMs and less capital constraint would increase banks’ capability to lower existing mortgage rates and more effective lower funding cost for households,” said the Goldman Sachs note.

Given the continued deterioration in property indicators, we expect more fiscal, monetary, property policy easing to boost confidence and support activity growth, the note added.

Meanwhile, citing Beijing’s less-than-expected policy support signaled by the Politburo meeting in July, UBS, the multinational investment bank and financial services company, downgraded China’s economic forecasts on Monday to 4.8 percent for 2023 and 4.2 percent for 2024.

“China’s economic growth has decelerated since April as the property downturn deepened, [with] no announcement of meaningful fiscal spending, and property easing has been relatively piecemeal and modest,” a UBS note said on Monday. “We now foresee a deeper and longer property downturn, revising our 2023 property starts down from a mid-single-digit decline to a contraction of 25 percent in 2023, and real estate investment from flat to about a 10 percent fall.”