US debt easing could lead to first reduction in China's key rate in four years, analysts said By Reuters

By Winni Zhou and Andrew Galbraith

SHANGHAI (Reuters) – China's central bank could cut its benchmark rate for the first time in four years if the US Federal Reserve offers a much-needed cut in late July, analysts say, as Chinese decision-makers step up support for slowdown of the economy.

Market observers, however, believe that the People's Bank of China (PBOC) is more likely to follow a decline in the US rate by lowering its key money market rates in the short term.

This would not be the first time the PBOC would follow the Fed's example. In 2017 and 2018, the bank raised short-term money rates a few hours after rising in the United States, although they are more modest and symbolic movements of 5 to 10 basis points.

While the Chinese authorities continue to downplay the likelihood of more aggressive easing, the economy has been slow to respond to a host of earlier stimulus measures, as the US-China trade war has begun. longer and more expensive.

Some analysts estimate that GDP growth is approaching the bottom end of the government's 2019 target range of 6 to 6.5 per cent, reinforcing expectations that more support is needed.

In an effort to stimulate more lending, the PBOC has poured huge amounts of liquidity into the financial system in various forms over the past year, targeting in particular small businesses and private companies. He also quietly guided some short-term rates downward to reduce the pressure on corporate finance.

However, analysts believe that investments have not been revived as much as expected, as the uncertain economic outlook leaves companies reluctant to make the new investments needed to stabilize the economy. In their view, a system-wide reduction in interest rates could provide troubled companies with more immediate relief.

"The current mechanism for transmitting monetary policy is stalled and the impact of quantitative regulation is therefore limited," said Ming Ming, head of fixed income research at CITIC Securities in Beijing.

"Lowering the interest rate is more appropriate for China now," he said.

CAUTION

Markets anticipated a 25-basis-point cut in US interest rates at the Fed's next meeting on July 30-31, and expect several more later this year and next year, at slowdown in the US economy.

China has not changed its benchmark lending or deposit rate to one year since October 2015, with the central bank preferring to use money market operations that affect short-term rates and special lending systems. direct credit to more vulnerable sectors.

A very energetic easing signal could put pressure on the Chinese currency and encourage capital outflows, while adding to the mountain of remaining debts of the credit spree of the past, according to analysts. The PBOC recently reportedly asked banks to stop cutting mortgage rates, in a climate of persistent concern over a housing bubble.

But a growing number of Chinese viewers now believe that a reduction in benchmark rates can not be ruled out if domestic and external economic conditions deteriorate further. The easing of monetary policy by the Fed would give the PBOC more leeway.

Prime Minister Li Keqiang has recently sparked hope for increased action by promising measures to reduce real interest rates on the financing of small and micro enterprises.

INVERSE PRICES

The PBOC has aggressively reduced the amount of cash that banks must hold as reserves six times since the beginning of 2018, and it is generally expected that they will continue to reduce these requirements.

In recent weeks, it has also stepped up its liquidity injections to calm the nerves of the market after regulators seized a troubled bank, raising concerns about financial contagion.

However, the record interbank lending costs, due to massive liquidation, have had unintended consequences.

On Tuesday, the benchmark one-day repo rate for banks dropped to 0.70%, the lowest since the data was released in 2003, and lower than the central bank's proposed interest rate. the commercial banks' excess reserves, which now stand at 0.72%.

Traders have stated that reverse rates cancel out interbank repo transactions by making it more profitable for banks to hold cash than to lend them.

Given the diminishing returns of money injection into the banking system, but wishing to avoid a destabilizing shock, most analysts believe that the PBOC will focus on adjusting short-term money rates.

Lu Ting, Chief Economist for China at Nomura in Hong Kong, said he expects the PBOC to follow the Fed by lowering quasi-political rates by "about 10 basis points" in order to to reduce the pressure on growth and employment.

Serena Zhou, an economist at Mizuho Securities in Hong Kong, said she's expecting any adjustment to echo the symbolic movements of 2017 and 2018.

"Reducing the repo rate by 5 basis points would not create a huge real impact, but would restore market confidence," she said.

Frances Cheung, head of macroeconomic strategy for Asia at Westpac in Singapore, also said that the PBOC could adjust free market transaction rates if market rates remain at low levels, allowing for "catch up with the market".

"In general, the need for cash or credit is still needed," she said.

The PBOC's seven-day repo rate is currently 2.55%.