China Delivers Largest Cut Yet To De Facto Benchmark, But ‘More Easing Measures Are Needed’

As expected, China slashed its de facto benchmark rate on Monday in a bid to provide ongoing support for the world’s second-largest economy, which posted an unprecedented contraction in the first quarter.

The cut to the loan prime rate was a foregone conclusion after the PBoC slashed the 7-day repo rate late last month and the medium-term lending rate last week.

The one-year LPR rate is now 3.85%, representing a 20bps cut, in line with the size of last month’s repo rate cut and consistent with the reduction in the MLF rate last Wednesday.

You should note that this is a large move relative to previous LPR cuts, which were doled out in 5bps increments sandwiched between an initial 10bps cut (versus the old benchmark) when the revamped rate was first published in August, and another 10bps cut in February. In other words, this move is twice the size of the largest cuts we’ve seen in the short history of the revamped LPR, and four times the size of the smaller cuts.

The five-year LPR tenor was cut by 10bps on Monday. The latest cut to the one-year rate pushes the discount to the old benchmark to 50bps. All loans are being transitioned to the LPR rate this year.

China completed the last round of easing on February 20, slashing both LPR tenors, with the one-year cut by 10bps to match an identical cut to the MLF rate and OMO rates (the 7- and 14-day repo rates) earlier that month, following a tumultuous reopening for mainland markets after the holiday, which was extended as the virus proliferated.

Monday thus marked the culmination of 2020’s second round of easing. This year’s reductions to OMO rates and the LPR come alongside RRR cuts which have freed up additional liquidity.

Remember, these cuts are part and parcel of an ongoing, holistic effort on China’s part to provide broad-based stimulus without “flooding” (as Beijing is fond of putting it) the market.

The monetary policy transmission channel in China became clogged last year, and while there are some signs of improvement, nobody is going to describe the country’s multi-tiered rates regime as “straightforward”. In a welcome development, total social financing last month was 5.15 trillion yuan, a full 2 trillion ahead of estimates and the highest monthly total on record.

Obviously, China’s easing push (which could fairly be described as “dribs and drabs” in the latter part of 2019) has taken on a renewed sense of urgency thanks to the effects of the epidemic.

GDP contracted 6.8% in Q1, Beijing said Friday, and activity data for March showed a disconcerting disparity between industrial output (which beat expectations) and retail sales (which disappointed).

Read more: China Reports Unprecedented GDP Contraction. And March Activity Data Reveals A Troubling Divergence

The news flow suggests more easing is in the cards going forward, although the challenge now is external demand, as the rest of the world struggles to restart their idled economies after a bruising battle with COVID-19.

“The policy relief so far has helped somewhat, being most evident in the notable acceleration in credit growth in March… but clearly more easing measures are needed, especially to cushion the income shock already inflicted on households and SMEs”, SocGen’s Wei Yao wrote Friday.

“Monetary policy has been stepped up significantly in the past few weeks, and more rate cuts can be expected ahead”, she added, noting that “the fiscal punch is lacking, and there is still no clarity on the budget”.

Beijing said Monday that fiscal revenue fell 14.3% in the first quarter. The contraction will narrow as the virus eases, the Finance ministry remarked. Other headlines out of Beijing to start the week include nods to avoiding mass layoffs, considering a larger fiscal deficit and implementing “more effective” targeted measures in “some areas”.