PBOC steps up rate cuts in response to Coronavirus

  • The People’s Bank has lowered the rates it charges banks for short-run liquidity. Given the mounting toll of the Coronavirus outbreak, we expect more cuts in the coming months.
  • The People’s Bank (PBOC) has just cut its 7-day reverse repo to 2.40% from 2.50% and its 14-day reverse repo rate to 2.55% from 2.65%. This is the second reduction to these rates this easing cycle. The first was a five basis point cut last quarter. The move is likely to be followed by cuts to the rates on the PBOC’s other lending facilities, which often move in tandem. (See Chart 1.)
  • Today’s cuts essentially lower the effective floor beneath interbank rates. (See Chart 2.) When market repo rates fall below the PBOC’s reverse repo rates, the central bank halts its open market injections and liquidity conditions gradually tighten as a result. The upshot is that the latest PBOC cuts will allow for a larger sustained decline interbank rates in response to PBOC injections, which were stepped up today.
  • Many banks rely heavily on the repo market as a source of day-to-day liquidity. Repo rates are therefore key in determining banks’ marginal funding costs. Cuts to the rates on the PBOC’s lending facilities should also feed through to a lower Loan Prime Rate (LPR), the benchmark upon which new bank loans are now priced and interest costs on existing loans are linked.
  • While this will take some pressure off of banks and borrowers, the rate cuts are too marginal to provide a substantial offset to the drag on economic activity from the Coronavirus outbreak. Indeed, with business and consumer confidence in the doldrums and appetite for borrowing weak, the rate cut will probably fail to lift credit growth much at all.
  • The upshot is that further loosening seems likely in the coming weeks unless there is a rapid improvement in the Coronavirus situation. We were already on the dovish side of consensus prior to the outbreak, with a forecasts for 50 basis points of PBOC rate cuts this year. We wouldn’t be surprised if the PBOC now lowers rates even more aggressively than that. At the very least, policy easing is likely to be heavily front loaded this year.

Chart 1: PBOC Policy Rates (%)

Chart 2: 7-day Repo Rates (%)

Sources: CEIC, Capital Economics

Sources: CEIC, Capital Economics

Julian Evans-Pritchard, Senior China Economist, +65 6595 1513, julian.evans-pritchard@capitaleconomics.com

Julian Evans-Pritchard Senior China Economist
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