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"We have the opportunity to reduce interest rates," said Liu Guoquiang, deputy governor of the People's Bank of China, during an interview with reporters in Beijing. "Whether we do it or not depends on economic growth and price conditions."
The LPR, which will become the new benchmark for banks in terms of loan pricing, is expected to better reflect the fluctuations in market rates. Some analysts have called this rate reduction. But it is unlikely that the tweak has a huge impact on the Chinese economy, which is in serious crisis.
"Although this should prompt banks to slightly reduce lending rates, the impact on economic activity will be marginal," wrote Julian Evans-Pritchard, chief economist for China's Capital Economics, in a report released Tuesday. He added that, contrary to a reduction in the reference rate, this decision "will only result in borrowing costs on new loans, not on outstanding ones".
As a result, the Chinese central bank "still has work to do," he wrote.
Asian markets bounced back on Monday after the central bank announced the new policy, but did not move much when the real rate was set. Chinese banks listed in Hong Kong have fallen somewhat, probably because this decision could affect the margins of bank loans. Real estate developers also fell back slightly – they jumped a day earlier.
Mr. Liu said the new reform was not intended to replace the other monetary policy of the country, adding that it was more of an improvement.
"We do not expect it to be a one-pony pony and that it will not solve all the problems," Liu added.
The central bank's decision on Tuesday is a slow and steady process, writes Ken Cheung Kin Tai, chief foreign exchange strategist for Asia at Mizuho Bank in Hong Kong. If policymakers make a dramatic change, banks may suffer.
"From the banks' point of view, a gradual migration" relying on the LPR "will help manage the evolution of loan demand," he added.
The news on Tuesday could help clear the burden of the central bank in Beijing, which calls for more drastic measures, wrote analysts Bank of America Merrill Lynch. But they added that China 's economic slowdown is expected to tighten government pressure for a reduction in benchmark rates later in the year.
The PBOC will need to balance calls for further rate reductions with its objective of maintaining the stability of the Chinese currency. Some analysts say that he might also want to avoid major measures that could draw attention to the magnitude of the economic downturn at a politically sensitive moment, which is approaching the 70th anniversary of the People's Republic of China on October 1st.
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