China Cuts Rates In Surprise Move As Data Disappoints

In what could plausibly be construed as a somewhat desperate move, China cut two key rates on Monday in an apparent effort to bolster the world’s second largest economy amid pervasive doubts around the feasibility of Beijing’s full-year growth target.

The PBoC cut both the one-year medium-term lending rate and the seven-day reverse repo rate, the first such moves in seven months.

The 10bps cut to the MLF rate (figure below) presumably sets the stage for a reduction to the one-year loan prime rate, the de facto benchmark, later this month. As a reminder, the LPR represents the best rates offered to customers by a handful of Chinese banks, but the one-year MLF rate is a factor. Typically, LPR reductions are presaged by MLF cuts.

Banks reduced the five-year loan prime rate, a reference for home mortgages, by 15bps in May. It was the largest reduction to that tenor since the PBoC revamped its rates regime in August of 2019.

Most analysts view the Party’s growth target for 2022 as unattainable. Although the economy recovered in June after virus containment measures crippled activity in the second quarter, recent data suggests the nascent rebound is faltering already.

Manufacturing PMIs for July were lackluster and credit data out late last week was woefully short of expectations. On Monday, activity data showed retail sales grew just 2.7% last month, slower than anticipated (figure below).

Industrial production was likewise tepid, rising just 3.8% versus a forecasted 4.3% gain. The surveyed jobless rate was 5.4%, down a tick from June’s 5.5%.

In the context of underwhelming credit demand, Monday’s rate cuts could be tantamount to pushing on a string. And yet, the PBoC has little choice. The central bank repeatedly pledged to support the economy during the first half, but opted for a cautious approach, easing only in dribs and drabs. The one-year MLF cut is significant.

Aggressive Fed hikes have arguably constrained the PBoC given the potential for policy divergence to spark capital flight. Inflation data out last week was relatively benign. Consumer prices rose 2.7% in July YoY, less than expected, albeit still the swiftest pace in two years (figure below). The increase was driven by a 20% surge in pork prices.

Producer price inflation in China is nowhere near the highs seen late last year. Factory-gate inflation was just 4.2% in July, amid lower commodity prices.

Of course, subdued inflation is in part a function of impaired demand. Policymakers have struggled to buoy consumer spending between lockdowns. Ongoing concerns about the real estate market and Xi’s never-ending regulatory crackdown have dampened sentiment further.

Suffice to say inflation is no obstacle to PBoC easing. If anything, the underlying trend (i.e., stripping out pork and elevated prices for fruits and vegetables), argues for a more assertive PBoC on the dovish side, as does decelerating activity.

But, again, there are concerns about the policy divergence with the Fed, and China is very keen to avoid even the appearance that policy is fostering bubbles. In a testament to that, Monday’s surprise rate cuts were accompanied by the withdrawal of liquidity — the PBoC didn’t roll all maturing funding.

The bottom line is the same as it’s been for months. The Party’s full-year target is laughable. The Chinese economy won’t expand by anything like 5.5% in 2022. In fact, it probably won’t expand at all. If it were possible to accurately measure Chinese economic activity (it’s not), we’d likely discover China is in a recession.