China Pivots on Central Bank Easing as Fed Heads for Taper

China made a surprise shift Wednesday by signaling the economy needs additional central bank support, a warning for the rest of the world about how circuitous the exit route from the Covid-19 pandemic is proving to be.

The State Council, China’s equivalent of a cabinet, hinted the People’s Bank of China could make more liquidity available to banks to boost lending. It’s a move that puts the PBOC at odds with the U.S. Federal Reserve’s discussions around tapering its bond-buying program, suggesting that monetary policy in the world’s two biggest economies could be headed in opposite directions again.

Economists pinned China’s pivot on emerging signs that a robust recovery is starting to cool as commodity prices soar, consumers remain cautious and global supply-chain problems hit businesses. Sporadic restrictions to contain virus outbreaks continue to hamper sentiment.​

China Pivots on Central Bank Easing as Fed Heads for Taper

The State Council suggested the PBOC could cut the amount of money banks must keep in reserve -- the so-called reserve ratio requirement, or RRR. While the shift in tone doesn’t mean the restart of broad-based easing in China, it’s an about-turn for a central bank that had been tapering its support as growth accelerated.

“As central banks the world over tip-toe toward the pandemic policy exit, they will do well to heed the experience of the PBOC,” said Frederic Neumann, co-head of Asian economics research at HSBC Holdings Plc. “Better proceed with caution in withdrawing policy support while the economy gets back on its feet.”

Bond Yields

For investors, China’s easing can offer a boost to its government bonds, which have been challenged by concerns over potential U.S. tapering and an upcoming deluge of local debt issuance in coming months. The move eases fears over higher funding costs in the country and should support risk assets, Citigroup Inc. strategists led by Gaurav Garg wrote in a note.

Government bonds rallied, pushing the benchmark 10-year yield below 3% for the first time since August 2020. The benchmark CSI 300 Index dropped as much as 0.8%, in line with the MSCI AC Asia Pacific Index, with investors saying a potential RRR cut would likely be a targeted move aimed at supporting smaller businesses rather than benefiting the broader stock market.

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China’s robust recovery from the pandemic has shown signs of faltering recently, with soaring commodities pushing factory-gate prices to an almost 13-year high in May and a gauge of activity in the services industry slowing sharply in June, partly because of virus outbreaks in some parts of the country.

“China and the U.S. can’t both go for growth at the same time, commodity inflation won’t allow it,” said Michael Every, global strategist for Rabobank. “China seems to think the U.S. is stalling on that front, so it can go for growth again.”

The State Council’s shift may indicate the government expects disappointing data when it reports second-quarter gross domestic product and June activity figures next week. Economists surveyed by Bloomberg expect a slowdown in GDP growth to 8% in the second quarter from a year earlier, compared to 18.3% in the previous three months.

What Bloomberg’s Economists Say...

The meeting may signal a turning point for liquidity conditions is approaching -- the PBOC may marginally ease liquidity from a previously tight tilt to a neutral or marginal easing stance. But overall conditions are unlikely to allow the PBOC to reduce interest rates.

-- David Qu, China economist

For full note, see here

Detailing its shift, the State Council agreed at a meeting chaired by Premier Li Keqiang to “use monetary policy tools, including a cut to the reserve requirement ratio at an appropriate timing to enhance financial support to the real economy, particularly to smaller businesses,” according to a statement Wednesday. That’s aimed at helping firms deal with the impact of rising commodity prices, it said.

“A shift to some kind of policy easing in the second half is no surprise,” Nomura Holdings Inc. economists led by Lu Ting said in a note. “But using a high-profile tool such as RRR cut is a big surprise to markets and us.” Nomura expects the central bank most likely will deliver a 50 basis-point universal RRR cut in coming weeks.

The State Council’s comments came a day after a former PBOC official called for China to cut interest rates in the second half of the year to safeguard the recovery and create policy room to deal with the Federal Reserve’s anticipated tightening.

Authorities are still wary of overstimulating the economy though, with the State Council saying it will refrain from flooding the economy with stimulus and will maintain the stability and effectiveness of monetary policy.

Previous Cuts

Allowing banks to reduce their reserves would free up the flow of credit to the wider economy. The PBOC hasn’t cut the official RRR since mid-2020, when it was trying to boost the economy after lockdowns to contain the Covid-19 outbreak.

The central bank hasn’t always followed through with RRR cuts: The last time the State Council suggested reducing the ratio was in June last year, but no action was taken by the PBOC.

Even so, the mention of RRR cuts after more than a year was “notable and probably increases the chance of an actual implementation of the cut,” Goldman Sachs Group Inc. wrote in a note. The State Council’s statement had a clear “pro-growth” shift, focusing on the need to increase financial support to the real economy, the economists said.

The central bank also has refrained from changing its policy interest rates since cutting them early last year, choosing instead to guide credit growth lower to curb financial risks. The central bank said last week it will maintain a steady policy and prevent “external shocks” from overseas policy changes.

China Pivots on Central Bank Easing as Fed Heads for Taper

China’s state media cited China Minsheng Banking economist Wen Bin as saying there could be a cut to the RRR for small and medium-sized financial institutions by the end of the third quarter.

A reserve-ratio cut, while not immediately lowering the cost of borrowing in China, is a rapid way of freeing up cheap funds to lend and has been one of the central bank’s favored tools in recent years.

The bank can cut the ratios for different types of banks or for different types of lending at specified banks, such as the “inclusive financing” RRR cut, which it has done annually since 2017.

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