Throwing in the towel on PBOC rate hikes - Capital Economics
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Throwing in the towel on PBOC rate hikes

China Economics Weekly
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Policy normalisation has run a long way already in China. Interbank rates have returned to near pre-pandemic levels. Credit growth has slowed. And a PBOC survey published yesterday signals that last year’s loosening of bank lending criteria has been fully reversed. What hasn’t happened though is any increase in the PBOC’s policy rates. That divergence between policy rates and monetary conditions reflects institutional constraints on the PBOC and the leadership’s economic priorities. We had expected (limited) policy rate hikes this year, but they no longer seem likely during this cycle.

PBOC may stop short of formalizing tighter policy

We had expected the PBOC to start hiking its policy rates this quarter given the strong economic backdrop. By the end of last year, output had rebounded well above trend and while headline y/y inflation remained low, there were signs of price pressures building in the m/m figures.

Instead, the PBOC has avoided formal policy tweaks – the Loan Prime Rate (LPR) was left unchanged for an eleventh straight month on Monday. It could be that January’s COVID-19 flare-up, which set back service sector activity and nudged up unemployment, has simply pushed back the timetable for rate hikes. But we now think that the PBOC may not formally raise rates at all this economic cycle.

The PBOC cut its policy rates by a mere 35bps in response to the pandemic. Instead, the bulk of monetary easing was achieved by pushing down market interbank rates with liquidity injections and loosening quantitative controls on bank lending.

The flipside is that policy normalisation mostly involves reversing these informal measures, a process that is largely complete. Market interbank rates are now back near pre-COVID levels. And the PBOC surveys published yesterday suggest that quantitative controls on bank lending are no longer particularly loose. (See Chart 1.)

Chart 1: PBOC Banking Survey (diffusion indices)

Sources: CEIC, Capital Economics

As such, the case for some modest PBOC rate hikes had less to do with monetary tightening and more to do with policy signalling and the desire to move towards a more orthodox policy framework where formal interest rate changes play a greater role, something PBOC officials have called for.

The main barrier to this shift appears to be the PBOC’s lack of independence. It has flexibility in managing day-to-day liquidity operations but formal policy rate changes require approval from the State Council. While China’s leadership wants to stabilise the debt-to-GDP ratio this year, officials are still emphasizing the need to keep corporate borrowing costs low. This political backdrop helps explain the odd mix of PBOC inaction on policy rates but rapid monetary tightening on other fronts.

Political opposition to rate hikes is, if anything, likely to increase over the coming quarters as economic growth drops back. Looking through the flattering base effects from last year’s downturn, there are already signs that China’s rebound is levelling off. And while service sector activity should recover now that domestic travel restrictions have been eased again, industry and construction look set to weaken as policy tightening weighs on investment and China’s pandemic-driven export boom fizzles out.

Renminbi turning a corner

We were right to turn bullish on the renminbi back in September. But the tailwinds that propelled the currency’s recent appreciation are fading. China’s economic outperformance will narrow as vaccine rollouts and US fiscal stimulus brighten the outlook for the rest of the world. This is already starting to be reflected in the US-China yield spread which is shifting against the renminbi. We now expect the currency to weaken from 6.54/$ currently to 6.70 by year-end and 6.90 by end-2022. See today’s Update for more.

The week ahead

The March PMIs are likely to show an uptick in manufacturing and services activity this month amid strong exports and a reduction in virus disruption.


Data Previews

Manufacturing PMIs (Mar.) Wed. 31st Mar./ Thu. 1st Apr.

Forecasts

Time (China)

Previous

Consensus

Capital Economics

“Official” PMI (31st Mar.)

09.00

50.6

51.2

51.5

Caixin/Markit PMI (1st Apr.)

09.45

50.9

51.3

51.5

Strong foreign demand should have boosted factory activity

The manufacturing PMIs continued to drop back from November’s multi-year highs in February. We think this downward trend partially reversed in March.

The March flash PMIs of China’s major trading partners rose, suggesting that foreign demand continued to strengthen. What’s more, the new orders component of the Standard Chartered SME Index also points to a pick-up in business activity in recent weeks. (See Chart 2.) And industrial metals prices, which correlate well with factory activity in China, have risen recently.

Chart 2: Manu. PMIs & SME Index – New Orders

Sources: CEIC, Markit, Bloomberg, Capital Economics

Non-manufacturing PMIs (Mar.) Wed. 31st Mar./ Tue. 6th Apr.

Forecasts

Time (China)

Previous

Consensus

Capital Economics

“Official” Non-man. PMI (31st Mar.)

09.00

51.4

52.0

52.0

Caixin/Markit Services PMI (6th Apr.)

09.45

51.5

52.1

52.0

Service sector activity recovering as virus disruptions ease

The services PMIs have dropped back since reaching multi-year highs in November. The decline was particularly steep in January as virus flare-ups and travel restrictions weighed on services activity. We think momentum has picked up in recent weeks as restrictions were lifted.

After softening in January and February, intracity passenger traffic is now back to normal levels. (See Chart 3.) This suggests that shoppers have returned to the streets, boosting retail sales. Cinema ticket sales remained strong even after the Lunar New Year festivities.

In contrast, construction activity, which is included in the official PMI, is likely to have slowed further. There was a sharp drop back in new housing starts at the start of the year, presumably a response to tougher restrictions on borrowing by developers. And reduced fiscal support this year points to a step down in infrastructure spending.

Chart 3: Passenger Traffic (% of 2019 level, 7d ave.)

Sources: Wind, Capital Economics


Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Country

Release/Indicator/Event

Time (China)

Previous*

Median*

CE Forecasts*

March

Sat 27th

Chn

Profits of Large Industrial Firms (Feb., YTD)

(09.30)

Tue 30th

HK

Retail Sales (Feb.)

(16.30)

(-13.6%)

(+44.0%)

(+34.0%)

Wed 31st

Chn

“Official” Manufacturing PMI (Mar.)

(09.00)

50.6

51.2

51.5

Chn

“Official” Non-Manufacturing PMI (Mar.)

(09.00)

51.4

52.0

52.0

April

Thu 1st

Chn

Caixin Manufacturing PMI (Mar.)

(09.45)

50.9

51.3

51.5

Fri 2nd

HK

Good Friday (National Holiday)

Also expected during this period:

TBC

Chn

Current Account Balance – Final (Q4, USD)

130.2bn

Selected future data releases and events:

April

3rd – 5th

Chn

Tomb Sweeping Day (National Holiday)

Mon 5th

HK

Day After Ching Ming Festival (National Holiday)

Tue 6th

HK

Day After Easter Monday (National Holiday)

Chn

Caixin Services PMI (Mar.)

Fri 9th

Chn

Inflation Data (Mar.)

Also expected during this period:

8th – 18th

Chn

Foreign Direct Investment (Mar.)

9th – 15th

Chn

Aggregate Financing “AFRE” (Mar., RMB)

9th – 15th

Chn

Net New Lending (Mar., RMB)

9th – 15th

Chn

M2 Money Supply (Mar.)

Main Economic & Market Forecasts

%q/q annualised (%y/y), unless stated

Latest

Q1 2021

Q2 2021

Q3 2021

Q4 2021

Q1 2022

2020

2021f

2022f

Official GDP

(+6.5)*

(+21.0)

(+9.0)

(+7.0)

(+5.5)

(+5.0)

(+2.3)

(+10.0)

(+4.5)

GDP (CE CAP-derived estimates)

(+7.6)*

(+31.0)

(+10.0)

(+5.0)

(+2.5)

(+3.0)

(+1.0)

(+10.0)

(+3.5)

Consumer Prices

(-0.2)**

(+0.1)

(+1.6)

(+2.2)

(+2.5)

(+1.8)

(+2.5)

(+1.5)

(+1.5)

Producer Prices

(+1.7)**

(+1.0)

(+2.5)

(+2.0)

(+1.5)

(+1.3)

(-1.8)

(+2.0)

(+0.5)

Broad Credit (AFRE)

(+13.3)**

(+13.0)

(+11.5)

(+10.5)

(+9.0)

(+8.0)

(+13.3)

(+9.0)

(+7.5)

Exports (US$)

(+60.6)***

(+31.0)

(+14.0)

(+2.0)

(+0.0)

(-2.0)

(+3.6)

(+9.5)

(+1.5)

Imports (US$)

(+22.2)***

(+17.5)

(+22.5)

(+12.5)

(+8.0)

(+7.0)

(-1.1)

(+15.0)

(+6.0)

RMB/$

6.54

6.55

6.60

6.65

6.70

6.75

6.54

6.70

6.90

7-day PBOC reverse repo %

2.20

2.20

2.20

2.20

2.20

2.20

2.20

2.20

2.20

1-year Loan Prime Rate (LPR) %

3.85

3.85

3.85

3.85

3.85

3.85

3.85

3.85

3.85

1-year MLF Rate %

2.95

2.95

2.95

2.95

2.95

2.95

2.95

2.95

2.95

10-year Government Bond Yield %

3.19

3.20

3.10

3.00

2.90

2.80

3.20

2.90

2.60

RRR (major banks) %

12.5

12.5

12.5

12.5

12.5

12.5

12.5

12.5

12.0

CSI 300 Index

4,926

5,000

5,150

5,275

5,400

5,525

5,211

5,400

5,900

Hong Kong GDP

(-3.0)*

(+3.0)

(+5.5)

(+4.5)

(+6.5)

(+7.5)

(-6.1)

(+5.0)

(+5.5)

Hang Seng Index

27,900

28,000

28,500

29,000

29,500

30,125

27,231

29,500

32,000

Sources: Bloomberg, CEIC, Capital Economics *Q4; **Feb.; ***Jan. & Feb.; End of period


Julian Evans-Pritchard, Senior China Economist, julian.evans-pritchard@capitaleconomics.com
Sheana Yue, Assistant Economist, sheana.yue@capitaleconomics.com