China set to cut lending rates as economic recovery drags

China is expected to make the biggest cuts this year to two of its core lending rates as pressure mounts on policymakers and banks to reverse slowing momentum and revive flagging demand in the world’s second biggest economy.

The People’s Bank of China is set to announce reductions to both one-year and five-year loan prime rates (LPR), which affect borrowing costs for businesses and households, at a monthly meeting on Monday, after making a surprise cut to its closely related medium-term financing rate last week.

Policymakers in Beijing have struggled to counter a host of challenges since lifting pandemic restrictions at the start of the year, including a property sector slowdown, weaker exports, record youth unemployment and price deflation as consumer confidence wanes.

In a statement released on Sunday the People’s Bank of China urged banks to increase lending to companies to bolster growth and stimulate consumption. The statement was released with China’s financial and securities regulators, which met on Friday to discuss the country’s “tortuous” economic recovery.

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The majority of economists polled by Bloomberg expect the one-year LPR, which underpins mortgage lending, to be cut by 15 basis points, the largest margin since January 2022. A similar cut to the five-year rate would be the biggest in a year. The LPR rates are currently 3.55 and 4.2 per cent respectively.

The polled economists were unanimous in anticipating a cut to the LPR, which typically follows a reduction in the medium-term lending facility. The MLF rate, which manages banking sector liquidity, is now 2.5 per cent, the lowest since it was launched in 2014 after last week’s cut.

Beijing has stopped short of unleashing major stimulus despite months of disappointing economic data, with consumer prices slipping into deflationary territory in July and growth of just 0.8 per cent in the second quarter against the previous three months.

But missed bond payments from real estate developer Country Garden and on savings products linked to investment conglomerate Zhongzhi this month have increased alarm among observers.

“We believe the risk of systemic concerns emerging in China remains low, though spread[s] will likely remain volatile until the macro volatility subsides,” Goldman Sachs analysts wrote on Saturday, adding that this “may require a more concerted easing effort by China policymakers”.

On Friday evening China’s securities regulator announced a series of reforms designed to boost investment in its capital markets, including encouraging share buy-backs to stabilise prices and cutting transaction fees for brokers.

The LPR is partly determined by China’s biggest banks, which are set to release financial reports for the second quarter this month. The one-year LPR, which was cut in June by 10 basis points, is closely watched because of its relationship to mortgage borrowing costs.

Analysts at Nomura projected further cuts to the one-year LPR to 2.35 per cent by the end of the year, while the MLF would be reduced by 15 basis points to 2.35 per cent.

“However, the real issue for the current growth downturn is low credit demand rather than insufficient supply of loanable funds,” they wrote. “At some point in time Beijing might be compelled to take more measures to stem the downward spiral.”

China’s real estate sector, which typically drives more than a quarter of economic activity, has been paralysed by a liquidity crisis over the past two years following the 2021 default of Evergrande, the world’s most indebted property developer. Last week Evergrande filed for bankruptcy protection in the US as part of a prolonged restructuring. – Copyright The Financial Times Limited 2023