China holds rate after Fed policy, shows signs of losing steam

China’s central bank held off from immediately raising borrowing costs following the US Federal Reserve, a decision that came just as economic data for May showed that the economy is losing steam.

With the prospect of fresh U.S. tariffs on Chinese exports approaching, the world’s second-largest economy is already slowing after a stronger-than expected start to 2018. A campaign to curb indebtedness at state firms and local governments, plus the effort to shrink the shadow-banking sector, are adding to a cyclical moderation in the pace of growth.

Industrial output rose 6.8% in May from a year earlier, versus a projected 7 percent, while retail sales expanded 8.5 percent, versus a forecast 9.6 percent. Fixed-asset investment rose 6.1 percent year-on-year in the first five months, compared with an estimated 7 percent -- the slowest increase in data back to 1999.

With a sharp deceleration in credit growth and the threat of a worsening trade dispute with the U.S., Chinese businesses face an increasingly uncertain outlook. The People’s Bank of China has tried to support growth by increasing liquidity, and even though it could still pace the Fed’s hike as forecast by economists, the fact that it hasn’t done so immediately is being interpreted as a sign of concern over the economy.

"It’s a rotten set of data on all fronts," said Michael Every, head of financial markets research at Rabobank Group in Hong Kong. "The PBOC is still throwing money into the economy at the longer end of the curve and housing is still booming in many cities yet obviously it’s not enough. The longer term implications are really serious and the trade war hasn’t even started yet."

Chinese equities were boosted by the news that the PBOC wouldn’t raise rates, before dropping after the economic data was released. The Shanghai Composite Index was down 0.3 percent after gaining as much as 0.5 percent, while the ChiNext gauge of small caps and tech stocks was also down 0.3 percent.

The central bank is studying policies to boost loans to smaller firms, PBOC Governor Yi Gang said Thursday in a speech to the annual Lujiazui Forum in Shanghai. The central bank will use monetary policy tools including reserve requirements and re-lending to support those companies, which contribute to about 80 percent of China’s employment and 60 percent of economic output, Yi said.

China has been trying to ensure liquidity supply to cushion any economic slowdown and help lenders meet repayment obligations. It boosted injections via the Medium-term Lending Facility last week to the most in more than a year to support smaller firms, while in April it cut the RRR by 1 percentage point, citing a similar goal. The central bank hasn’t changed the benchmark one-year lending rate since October 2015.

While economists are interpreting the lack of an increase in the 7-day reverse repurchase rate on Thursday as a signal of easing policy, the central bank can react at any time to the Fed’s decision, particularly if downward pressure on the yuan materializes.

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“It’s possible that the PBOC will follow in due course,” writes Tom Orlik, Chief Economist at Bloomberg Economics. “The decision not to do so today looks like an indication that the PBOC is more focused on supporting growth and alleviating financial stress as markets fear an increase in corporate defaults.” 

The decade-long decline in investment has intensified this year, as policy-makers act to reduce leverage at state-owned companies and local governments. While that’s a deliberate policy, officials risk a faster-than-desired deceleration in growth.

• Fixed-asset investment rose at the slowest pace in the first five months since data began in 1999
• Growth of fixed-asset investment in the services sector also unexpectedly decelerated to 7.7 percent in the first five months, the slowest pace since at least 1998
• Infrastructure investment growth decelerated to 9.4 percent in the first five months, the slowest pace since data began in 2014

Economists surveyed by Bloomberg see a 6.5 percent expansion this year after 6.9 percent in 2017, in line with the government’s own target.

A gauge of early indicators developed by Bloomberg Economics in May showed some sectors of the economy slowing while others, buoyed by global trade, held up. With U.S. President Donald Trump now saying he’ll confront China “very strongly” over alleged trade abuses, that support to the domestic economy could also be under threat.

China’s broadest measure of new credit slumped in May to the lowest in almost two years, as a campaign to rein in the shadow banking sector gained traction. With the decline coming mainly on the back of weaker shadow-banking activity, that development is also a desired outcome of policy makers’ attempts to rein in risk.

That leave the central bank on point to mitigate the impact to the economy, said Nathan Chow, senior economist at DBS Bank Hong Kong Ltd.

"The liquidity strains are already having an impact on the economy," he said. "To stabilize growth, PBOC will show greater policy flexibility. A RRR cut is desired; especially given the huge amount of bonds maturing and MLF due in the second half. This, along with the ongoing trade tension, will add pressure on the yuan exchange rate in the second half."

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