China didn’t “follow” the Fed by cutting money market rates this week as some anticipated, but the door was still open for the second vintage of the revamped loan prime rate to tick lower, and sure enough, it did.
The 1-year LPR rate for September is 4.20%, representing a 5bps cut from the inaugural print last month. The 5-year tenor is unchanged at 4.85%.
As a reminder, China moved to simplify its two-track rate regime this year in a bid to bring down average borrowing costs. That effort culminated in a new LPR compiled from bank submissions representing the prices they charge their most credit-worthy clients expressed in basis points over open market operation rates, with an emphasis on the medium-term lending facility.
The PBoC plays a role in setting the rate too. Just like anything else in Chinese markets, they can “guide” it. The actual formula is: LPR = MLF rate (1y MLF is 3.3%) + adjustment factors [banks’ funding costs + market supply and demand + risk premia and other parameters]”.
Chinese equities responded negatively earlier this week when the MLF rate was left unchanged, but with LPR at 4.25% versus 3.3% for the one-year medium-term lending facility, LPR still had the potential to fall, especially considering the latest RRR cut went into effect on Monday.
If it sounds complicated, that’s because it is. Indeed, the irony of the PBoC’s effort to “simplify” things was that by untethering LPR from the official benchmark rate (the one-year lending rate) in a bid to push it down towards MLF, the PBoC risked creating yet another key rate.
In any event, LPR is now gradually diverging from the one-year lending rate (orange arrow in the visual), and is now 15bps below the old benchmark. As noted (and linked) above, the broad RRR cut (white arrow below) went into effect on Monday.
Recent data underscore the need for more easing. Most notably, industrial production came in much worse than expected for August (some called it downright “shocking”), with output rising just 4.4% YoY, missing estimates badly, and dashing hopes of a rebound from July’s print, which itself represented the slowest pace of growth in 17 years.
The disappointing activity data (which also featured misses on retail sales and fixed-asset investment) came on the heels of an unexpected contraction in exports for August.
Friday’s LPR cut likely won’t be cause for celebration, especially as Beijing kept OMO rates unchanged this week, indicative of a desire to avoid flooding the economy with liquidity in favor of sticking judiciously to a “targeted” approach to easing.
Meanwhile, the PBoC said it would sell 10b yuan of bills in Hong Kong later this month.