The recovery of the economic fundamentals is expected to be significantly slower compared to the rapid rebound observed in 2020. The monetary environment is anticipated to remain accommodative for an extended period, with interest rates likely to stay at low levels until corporate and household financing demands normalizeThis prolonged period of low interest rates is a response to the sluggish recovery, as policymakers aim to stimulate borrowing and spending.
On August 15, the central bank took decisive action by lowering the 7-day reverse repurchase rate and the Medium-term Lending Facility (MLF) rate by 10 basis points, intentions aimed at invigorating the marketSubsequently, loan market interest rates for one year and longer tenors were asymmetrically reduced, prompting government bond yields to fall to new lows for the yearHowever, amidst market profit-taking pressures, differing views on future policy direction emerged, indicating a level of uncertainty.
The obstacles to the transmission of broad monetary easing into broader credit availability persist, particularly given the weak endogenous growth dynamics within the economyAs a result, it cannot be completely ruled out that another round of interest rate cuts could occur in the fourth quarterStakeholders don’t need to excessively worry about a turning point leading to a trend reversal in interest rates.
The overarching trend shows that the centrality of interest rates is moving downward across the board.
Since 2022, the central bank has maintained a loose monetary stanceOn a quantitative basis, a reserve requirement ratio cut of 0.25 percentage points was implemented in April, and by the end of July, approximately 1 trillion RMB in profit reserves had been deployed, equating to a near total reduction of almost 0.5 percentage points
Advertisements
Price-wise, significant policy rates including the 7-day reverse repo rate, 1-year MLF rate, and various tenors of the Loan Prime Rate (LPR) were also reduced to differing extents.
In the context of the central bank’s accommodative strategy and weak financing demands, an "asset shortage" scenario has developed, leading to pronounced declines in market interest ratesThe abundance and protracted availability of liquidity exceeded market expectations, causing dramatic drops in funding rates—an unprecedented low of around 1% was recorded for the DR001. The DR007 fell to a minimum of 1.29%, and interbank certificate of deposit rates saw declines nearing 70 basis points, both reaching historic lows since May 2020. The impact of policies aimed at stabilizing growth was reflected slowly in the long-end pricing of bonds, resulting in a steepening yield curveCompared to the end of 2022, the yield gap of the 10-year versus 1-year government bonds widened by 30 basis points, while the AAA-rated medium-term notes experienced a 39 basis point widening.
Three rounds of asymmetric reductions to the LPR since 2022 have illustrated a clear policy shift regarding the real estate sectorNotably, the 5-year rate was cut by 20 basis points more than the 1-year rate, narrowing the differential to 65 basis points—close to the historical low of 60 basis pointsThis LPR decrease has driven the average weighted loan interest rate down by 35 basis points year-on-year to 4.41%, marking an all-time lowFurthermore, the personal mortgage rate, as of the second quarter's close, decreased by 101 basis points compared to the end of 2021, dipping below the general loan rate for the first time since 2020. The recent cut in the 5-year LPR consequently holds the potential to drive housing loan rates even lower, possibly breaking the 4.52% threshold set in 2016 by the third quarter.
Looking forward to the fourth quarter, there remains a possibility for further rate cuts.
The central bank’s second-quarter monetary policy report emphasized the commitment to avoid excessive monetary flooding or over-issuing currency, indicating that market expectations for substantial looseness in monetary supply are tempered
Advertisements
The third quarter is recognized as a period for observing policy effects, leading to a lower probability of immediate cuts; however, the prospect of MLF and LPR reductions in the fourth quarter remains viableCurrently, structural inflation does not form a critical concern, and the constraints on rate hikes in response to economic downturns abroad have lessenedIf the recovery of the domestic economic fundamentals does not proceed as hoped, or if unexpected risks emerge within the real estate sector, further monetary easing could be warranted.
From the perspective of the necessity for rate cuts, real estate and ongoing pandemic risks significantly influence the trajectory of China's economic operationThe trends of these two macro factors dictate the pace of credit recovery, thereby impacting the essentiality of initiating rate cuts to stimulate total demandIndustries related to real estate contribute approximately 30% to GDP; as the real estate cycle declines, it adversely affects upstream and downstream businesses, banking systems, household sectors, and governmental budgets through four key channels: property development loans, mortgage loans, land finance practices, and overall economic drag.
Since the second quarter, the convergence of risks stemming from real estate and the pandemic has obstructed the flow of broad creditIn July, loans extended to non-financial enterprises and households saw year-on-year declines of 145.7 billion RMB and 284.2 billion RMB, respectively, with the growth differential between M2 and social financing widening to 1.1%. This reflects weak financing demands in the real economy and a continuing trend of private sector deleveragingIn light of an August LPR rate cut, the first and second property loan rates could potentially decline to 4.1% and 4.9%. However, high-frequency data on property transactions in 30 major cities have continued to indicate sluggish activity since July; this suggests that current residential loan rates may not significantly invigorate buyer enthusiasm, as most existing mortgage repricing won’t occur until January 2023, leading to a lagged effect on housing sales.
Contrastingly, regarding the feasibility of further rate cuts, additional reductions to the LPR hinge on adjustments to deposit rates
Advertisements
As part of the mechanism for market-oriented adjustments to deposit rates, member banks typically reflect on rates represented by the 10-year government bond yields or the 1-year LPR to rationally align their deposit ratesThe nationwide average of new deposit rates was recorded at 2.37% in the final week of April; however, as of August, the 10-year bond yield had dropped by over 20 basis points since AprilThe theoretical room for deposit rates to decrease lies within 5-20 basis points, yet no significant adjustments in rates among major commercial banks have been observed recentlyGiven that the current MLF rate is considerably higher than the 1-year interbank deposit rate, the signaling impact of MLF cuts is more significant than the actual outcome, as the cost of bank liabilities remains largely influenced by deposit ratesMaintaining stable net interest margins for commercial banks is essential; thus, if deposit rates fail to effectively follow the downward trend in market rates, this limits the sustained decline in LPR.
A forward-looking analysis of interest rate trends indicates that, despite the significant disparity between the 7-day reverse repo rate (2.0%) and DR007 (1.4%), the fund rates did not decline further following the August cutsEven with potential future reductions to both the 7-day reverse repo and MLF rates, the impact on fund rates will be minimalIt is anticipated that liquidity will continue to be accommodative, but as growth-stabilizing policies are progressively implemented, and government departments leverage additional financing to fill demand gaps, improvements in funding logjam conditions may ariseExpected stabilization of overnight and 7-day repo rates at lower levels indicates limited chances of breaking through previously low thresholds.
Historically, in February and April 2020, the central bank reduced the MLF rates by 10 and 20 basis points, respectively, subsequently causing a total decline in the 10-year bond yields of 40 basis points
Advertisements
Advertisements