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The People’s Bank of China surprised market expectations this morning, cutting the 5-year Loan Prime Rate (LPR) instead of the 1-year LPR, and against our forecast of no-change to either rate.
1-year Loan Prime Rate: 3.45% (exp: 3.4%, Monex: unchanged at 3.45%)
5-year Loan Prime Rate: 3.95% (exp: 4.1%, Monex: unchanged at 4.2%)
In our view, the motivation to calibrate monetary easing in this fashion is two-fold. Firstly, by cutting the 5-year rate, the PBoC aims to provide more targeted stimulus to the economy, isolating the property market specifically.
This is because the 5-year LPR is the reference rate for mortgages. By comparison, the 1-year LPR is the benchmark used to price the majority of bank loans, largely to consumers and corporates, and as such is seen to be a broader instrument. Having lowered the 1-year LPR twice in 2023 to no avail, the PBoC is now seeking to boost consumption indirectly by supporting confidence in the property market. Second, by calibrating the stimulus in this manner, the PBoC aims to reduce the negative side effects of effectively loosening monetary conditions. By holding the 1-year LPR at 3.45% and the 1-year MLF at 2.5% over the weekend, the PBoC continue to support Banks’ net interest margins just months after they hit all-time lows. Additionally, it also avoids eroding the yuan’s level of carry, any reduction of which would be counterproductive to the PBoC’s efforts to stabilise the currency in an attempt to further support economic sentiment, especially as USDCNY trades near the top of its daily trading range (chart 1: spot 7.1975 vs ceiling of 7.2489).
Looking ahead, with the Federal Reserve unlikely to move on rates until May under our base case, we don’t expect the PBoC to loosen monetary policy further until late-Q2, where we expect another 25bp cut in the RRR.
Although not deteriorating, this should keep interest rate spreads unfavourable for the currency. With the latest easing measures unlikely to have a profound impact on China’s growth data in the coming months, and wide-sweeping fiscal stimulus also unlikely in the near-term given the reluctance by policymakers to do so thus far and the adverse risk this could have on sentiment due to concerns over debt sustainability, this should sustain the current soft-peg regime in USDCNY in the coming months.
Chart 1: Not much more room to go – USDCNY trades close to the top of the PBoC’s daily trading range
PBoC’s decision has regional spillovers
The decision to configure monetary loosening this way has important spillovers in the region. The 25bps cut to the 5-year benchmark is the largest since the LPR rates were introduced in 2019. Psychologically, this reflects how dire the current housing situation is, and as such, we think the signalling effect undermines the impact of the stimulus on market sentiment. This explains why the reaction in markets to today’s announcement has been relatively narrow, with gains primarily concentrated in property stocks. In fact, the reaction in commodity markets has been negative, with next delivery iron ore prices falling 5% on the day to a fresh three-month low (chart 2), while steel and aluminium prices are also down around a percent on the day. This is having a negative repercussions on APAC currencies that export raw materials to China. The Malaysian ringgit is a prime example of this, with the currency falling a further 0.3% on Tuesday (chart 3), reaching its weakest level since it recorded an all-time low of 4.885 in 1998, as the negative terms-of-trade shock coincides with January’s trade balance data showing a smaller-than-expected surplus.
While there are reasons to suggest that USDMYR will rebound over the course of the year, downside pressures on the ringgit remain pronounced in the near-term. Whether the central bank can hold policy rates in an attempt to buffer these short-term pressures will be dependent on how Friday’s inflation data prints.
Chart 2: PBoC’s actions have narrow impact on markets
Chart 3: It’s one-way traffic for the ringgit as it trades -4.5% YTD and reaches lows not seen since the Asian Financial Crisis
Additionally, by concentrating the stimulus efforts on the housing market rather than directly influencing consumption through shorter-term interest rates, the PBoC has killed off expectations of a quick rebound in consumer demand. This has weighed on the tourism-dependent Thai baht this morning too, as it adds further downside risks to the economy’s outlook after Q4 GDP undershot expectations by a considerable margin earlier in the week, contracting by 0.6% QoQ at the end of last year. Weak growth rates and little support externally from the Chinese consumer has prompted Thailand’s Prime Minister Thavisin to renew calls for an emergency rate cut from the BoT, bringing the rift between the government and the central bank back into focus for investors.
Weak growth rates and the rising risk of political interference in monetary policymaking has resulted in the Thai baht going from the best performing currency in the region in Q4, to the second-worst performer in Q1 (chart 4).
Chart 4: The Thai baht goes from best in class in the region to one of the worst as investors begin to shun Thai assets
Author:
Simon Harvey, Head of FX Analysis