A pedestrian walks past the People’s Bank Of China (PBOC) headquarters at night in the financial district of Beijing, China. (Photographer: Tomohiro Ohsumi/Bloomberg)

A China Interest-Rate Cut May Be on its Way. But Which Rate?

(Bloomberg) -- China’s slowing economy and muted inflation are spurring predictions the central bank will act to lower borrowing costs. Problem is, analysts can’t agree on which rate is the one most likely to be cut.

The People’s Bank of China controls a wide array of monetary tools. The most aggressive step would be to lower the benchmark interest rate for the first time since 2015, reducing the cost of borrowing across the economy, but raising the risk of yuan weakness and asset bubbles.

A more consensus view is a reduction in costs for short- and medium-term funds for banks, steering borrowing costs lower by proxy. Others argue a lesser-known loan rate set by lenders themselves may be guided lower.

Whichever tool is preferred, a rare window is opening up for China to cut should it be deemed necessary, as a more cautious Federal Reserve eases the depreciation pressure on emerging market currencies, including the yuan.

“An interest-rate cut is quite likely,” said Nathan Chow, a senior economist at DBS Bank Hong Kong Ltd. The PBOC may reduce the benchmark rate by 25 basis points by the end of the second quarter, he added. “Such a move will encourage banks to lend more, as it makes costs of funding much cheaper.”

Here are the rates the PBOC may cut and their impact:

Benchmark Interest Rate

A reduction of the benchmark one-year lending rate -- which stands at 4.35 percent -- is neither widely expected nor straightforward.

The move has power, as it cuts the cost of funding for everyone, including mortgage borrowers. But it could pressure the yuan, via a plunge in sovereign yields that would make Chinese assets less appealing compared with those denominated in the dollar. It also runs counter to the tone of the long-running financial cleanup campaign, as it encourages investors to pile into already-inflated assets like property.

For those reasons, expectations of a cut to the benchmark have been muted until relatively recently. Indeed, the median economist estimate in a Bloomberg survey sees no change in the one-year lending rate this year or next.

The number of analysts forecasting a cut in the benchmark in the second quarter has however risen to six from four in December, including Jian Chang at Barclays Plc. A reduction of 25 basis points to the rate is "imminent," and that can happen as soon as this week, according to Cliff Tan, MUFG Bank Ltd.’s East Asia head of global markets research.

A China Interest-Rate Cut May Be on its Way. But Which Rate?

Interbank Rates

A more consensus view is that the PBOC may cut the rates it charges on reverse repurchase agreements via open market operations, and on funds via the Medium-term Lending Facility. Such steps make it cheaper for banks to borrow, a benefit they may pass on to the public. Also, there could be a reduction on rates of the Standing Lending Facility, which is the Chinese equivalent of the Fed’s Discount Window, from as early as February, Citigroup Inc economists led by Liu Li-gang wrote in a note.

The PBOC seems to favor this route, for now. The central bank has been gently guiding interbank borrowing costs down without actually cutting the official rates, largely by replacing funding accessed by banks via more expensive routes, such as the medium-term lending facility, for cheaper shorter-term cash. In the case though that the slowdown in the economy worsens, this method is unlikely to be enough to restore confidence and maintain lending.

Loan Prime Rate

The loan prime rate, which is now at 4.31 percent, is a weighted average rate that an arm of the PBOC publishes daily based on the costs on loans that major lenders charge to their best clients.

The authorities can push the LPR down by giving banks window guidance or cutting the money market rates, which then leads to drops in the LPR, Citic Securities Co. analyst Ming Ming wrote in a recent note. While lowering this rate sends a milder signal than reducing the benchmark, the move can be effective as the amount of credit priced with the LPR is rising, they wrote. Mizuho Securities Asia Ltd. says a LPR cut could be "around the corner."

No Rate Cut at All?

Incoming economic data at the beginning of the year is notoriously hard to read, given the distortions caused by the Lunar New Year shutdown. The underlying momentum of the economy may be very uncertain until well into the second quarter.

Some economists see a pickup on the back of last year’s stimulus policies arriving by then. Credit data are already indicating stronger demand, signaling that indirect efforts to spur activity may be working. By the time a rate cut becomes feasible, the moment may have passed.

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