China holds key interest rate as economy prepares for 'difficult year'

China’s central bank held a key interest rate as concerns about yuan volatility and the still-distant prospect of Federal Reserve easing limit the room policymakers have to support the economy.
 

The People’s Bank of China maintained the rate on its one-year policy loans on Monday, disappointing investors expecting the first trim since August. While the central bank pumped more cash into the system to meet demand for funding, another round of weak credit numbers on Friday had bolstered expectations for bolder steps.
 

“In light of the weak data, a cut would probably have undermined the yuan and led to unwanted currency weakness,” said Robert Carnell, regional head of research for Asia Pacific at ING Groep NV. “I think the authorities are quite constrained with what they can do — and so I’m neither disappointed or surprised, but I am resigned to this being another difficult year.”
 

Figures released Friday showed China marked its longest deflationary streak since 2009 in December, while financing and loan growth last month missed expectations and exports fell annually last year for the first time since 2016. 
 

President Xi Jinping’s government is grappling with weak domestic demand, a prolonged property crisis and the sluggish job market as it looks to target an ambitious growth goal this year. More comprehensive 2023 data due Wednesday will paint a clearer picture.
 

Chinese stocks traded slightly higher at the mid-day break, erasing losses from just after the PBOC rate decision. The offshore yuan rose 0.1% to 7.1812. The yield on China’s 10-year government bonds was steady at 2.52%.
 

Uncertainty over the Fed is one complicating factor for the PBOC. US consumer prices accelerated at the end of last year, throwing some cold water on the idea the central bank may start cutting rates as soon as March. The rate differential between the two economies has grown over the past year.
 

“The MLF non-cut this morning does suggest there’s not a lot of urgency in terms of adding more stimulus,” said Frederic Neumann, chief Asia economist at HSBC Holdings Plc., told Bloomberg TV. “You don’t want to cut too rapidly in China, and so you might want to use liquidity injections and other types of credit easing tools rather than an outright rate cut.”
 

The PBOC is watching more than just the Fed. It has to consider how its actions affect the yuan, which has weakened in recent weeks after a strong run to close out 2023. Lenders are experiencing record-low net interest margins as well, so they may need more time to reduce their funding costs before being able to absorb the impact of lower borrowing rates.
 

The central bank’s decisions over the past year have failed to move the needle. Despite efforts by policymakers to cut mortgage rates, for example, Chinese households are still putting off plans to buy homes.
 

The central bank has worked over the past year to encourage lenders to extend more loans. But those efforts seem to be falling short. Recent data has shown people are shifting their money out of risky wealth management products and putting it in more stable time deposits instead, according to analysts including Australia & New Zealand Banking Group Ltd.’s Xing Zhaopeng.
 

“The root problem of the weaker-than-expected economic recovery is not that financing costs are too high, but rather that demand is insufficient and confidence is weak,” said Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered Plc. “Some people think we should lower interest rates to zero, but that’s probably not the right remedy. The most important thing is to lift confidence.”
 

A senior central bank official hinted the PBOC may cut the reserve requirement ratio, or the amount of cash banks must hold in reserve. While not as aggressive a move as a policy rate cut, reducing the RRR would unleash money into the financial system, thereby helping banks buy government bonds that would be issued to finance infrastructure spending.
 

“We think there is still room” in the first quarter for a policy rate cut and potentially a reduction in the RRR, said Xiaojia Zhi, head of research at Credit Agricole CIB. She cited “still-lingering deflation and the need to lower real rates and support liquidity.”
 

The central bank took several fairly bold steps in December to support the economy short of a rate cut. It rolled out a record 800 billion yuan via the MLF to lenders and injected more cash into the banking system. The PBOC also provided 350 billion yuan worth of low-cost funds into policy-oriented banks in the month to finance housing and infrastructure projects. 

What Bloomberg Economics Says ... 
 

“The People’s Bank of China’s surprise hold on its one-year interest rate doesn’t change our view that it will guide borrowing costs down further soon.
 

“An economy that is losing momentum — weighed down by a housing rout and deflation — needs more support. We continue to expect the central bank to cut its key rate by 10 basis points and the reserve requirement ratio by 25 bps this quarter.”

— David Qu, economist
 

And there still probably will be room for the kind of policy rate cuts the PBOC avoided on Monday — once the Fed changes tack.
 

“A turn of the Fed’s policy stance will soon bring an end to the PBOC’s painful period of monetary policy divergence with all major central banks in the world,” said Becky Liu, head of China macro strategy at Standard Chartered Plc. “A dovish turn of the Fed will offer more room for the PBOC to ease in 2024, to better reflect China’s economic and inflation fundamentals,” said Becky Liu, head of China macro strategy at Standard Chartered Plc.