On Friday, we brought you the latest on China’s efforts to simplify its two-track rate regime.
Long story short, banks will submit the prices they charge to their most credit-worthy clients in terms of basis points over open market operation rates, with an emphasis on the medium term lending facility.
Those submissions will, in turn, inform a new loan prime rate (both a 1- and 5-year version), which will be released on a monthly basis, starting Tuesday. The first 1-year LPR under the new regime was released on schedule and it is 4.25% for August, which would appear to represent a 10bp rate “cut” versus the 1-year lending rate. The five-year tenor is set at 4.85%.
Drilling down into the specifics, Barclays notes that the new LPR “will be determined by the MLF rate with adjustment factors decided by quotation banks”. So, if what you’re looking for is an equation, it’s actually this (from Barclays):
LPR = MLF rate (1y MLF is 3.3%) + adjustment factors [banks’ funding costs + market supply and demand + risk premia and other parameters].
The idea here is actually pretty straightforward. The new system is aimed at bringing down the LPR, which, rather than being priced off the (higher) benchmark 1-year lending rate (as it was previously), will be based on OMO rates. Beijing wants to bring down the dark blue, squiggly line in the following chart:
This effort to reform the rates regime comes at a time when calls for more headline easing (as opposed to piecemeal, targeted RRR cuts and TMLF) are growing amid a string of lackluster data and what certainly appears to be an intractable stalemate with the Trump administration on trade.
The idea is to accomplish two things at once: Lower borrowing costs and call the reform effort largely complete. Apparently, the PBoC will attempt to control funding costs whether short-, medium- or long-term, via OMO rates, which seems somewhat optimistic, but we’ll see. There’s also no confirmation about what, exactly, is going to become of the benchmark 1-year lending rate, which was already seen as antiquated, and is, as of Monday, a dinosaur. Rates on the existing stock of loans and mortgages will be unchanged.
To be sure, there is some debate about whether or not this is going to work as planned, although most PBoC watchers seem to agree the bank’s intentions are good.
“We note financing costs for the real economy failed to decline in H1, with the PBoC’s quarterly weighted average lending data remaining broadly unchanged in H2 [while] the LPR has stayed at ~4.3% since Oct 2015 as it was mainly referenced to the 1y benchmark lending rate”, Barclays writes, adding that “we think the PBoC will guide the new LPR lower, thereby reducing overall medium- to long- term lending rates for the real economy”.
BofA is somewhat skeptical. “The PBoC will potentially coerce banks to lower the first few LPR quotes so as to show this new LPR reform can kill two birds with one stone”, the bank said Monday, before cautioning that “LPR doesn’t impact deposit rates or help reprice existing loans [and] it’s not equivalent to traditional rate cuts”.
“The new system itself doesn’t guarantee the actual lending rate will be lower [as] this depends on whether the OMO rates become lower, liquidity conditions and government window guidance”, Goldman says, before noting the obvious, which is that “given the current situation with weak activity growth, heightened trade war risks and a strong desire by the senior leadership to lower rates, we do expect actual lending rates to go down”.
So, you can probably expect MLF and OMO cuts next month, likely after the imposition of new tariffs by Trump on September 1. That should mean that the second LPR release will bring lower borrowing costs on September 20 (the rates are published on the 20th of each month).
Conveniently, that’s two days after next month’s Fed meeting.
Read more on the evolution of Chinese monetary policy