Via Goldman Sachs' Yu Song,
The PBOC cut the benchmark lending and deposit rates by 40 bp and 25 bp, respectively. Meanwhile, the deposit rate ceiling was increased to 1.2 times the benchmark deposit rate (from 1.1 previously), effective from Nov 22. The one-year benchmark lending rate will stand at 5.6% (vs 6% previously) and one-year benchmark deposit rate at 2.75% (vs 3% previously).
The change is in response to the weakness in economic growth and falling inflation. High-frequency data available to select government officials may have shown significant weakening, which was likely impacted by (1) the APEC related shutdowns, (2) weakening of underlying export growth amid mixed global activity growth and the recent appreciation of the CNY exchange rate and (3) tighter domestic liquidity conditions. Although nominal interest rates have been relatively stable, real rates have been on the rise in recent months amid lower inflation, which is effectively monetary tightening.
The effects of the cut in the benchmark lending rate are likely to be small since lending rates are not currently subject to either upper or lower limits. It may however be slightly useful to borrowers in negotiations with lenders, in our view.
The deposit rate is effectively unchanged (one-year deposit rate will range from 2.75% to 3.3% vs previously from 3% to 3.3%) because the cut in the benchmark rate is fully offset by the rise in the deposit rate ceiling (assuming commercial banks utilize nearly 100% of the upside from the benchmark rate to the ceiling. We believe they will be likely to do so given the competition for deposits). We believe the reluctance to cut the deposit rate could be because the government wishes to avoid any negative impact on household income growth.
Thus the move itself is unlikely to have a big direct impact on the economy. But the indirect effects could be meaningful because today's move sends a very clear signal to the market on policy intention. When the government intends to loosen its macro policy stance, it typically uses a range of policy tools instead of relying on just one or two. Full RRR cuts face a higher hurdle as they have more substitutes such as targeted RRR cuts, relending and its equivalents (PSL, MLF etc.). We expect the government to step up fiscal expenditure allocation and add more pressure on local government to act to support the economy, especially via speeding up infrastructure construction. These measures were the key in the growth rebound in 2Q of this year and will likely to be supportive of growth again in the rest of the year.
This is nevertheless a positive step in interest rate liberalization, in our view.
