PBOC RRR cut – Front Loading Policy Support
On Friday 17th March, the People’s Bank of China (PBOC) announced a broad-based 25bps Reserve Requirement Ratio (RRR) rate cut (Fig 1a), releasing additional liquidity into the banking system and reducing commercial bank funding costs. While the timing of the cut was a surprise, recent hints by Governor Yi Gang at the National People’s Congress had raised expectations of additional monetary policy support for China’s nascent economic recovery. The central bank’s accompanying commitment to “better support key areas” of the economy combined with muted inflation suggests market driven interest rates are likely to remain low and range bound for the foreseeable future.
Front loading monetary policy:
Announcing the rate cut, the PBoC committed to “keep monetary policy targeted and powerful”. The universal rate cut, effective 27th March, will reduce the weighted average RRR from 7.80% to a new cycle low of 7.60%. For large and medium banks, the rate will decline to 10.75% and 8.75% respectively, while smaller banks are already at the RRR floor of 5%. The rate cut will release approximately CNY500bn of additional liquidity, while reducing commercial bank funding costs by approximately CNY5.5bn per annum.
The PBoC hopes the permanent liquidity injection will encourage bank lending and support credit growth. Combined with the recent reappointment of PBoC Governor Yi, it should boost market confidence and send a strong pro-growth signal. Nevertheless, the small size of the cut indicates usage of the RRR, which is the central bank’s most active monetary policy tool of the last five years, is reaching its lower limits.
Market driven SHIBOR yields (Fig 2b) have continued to increase from cycle-lows reached in September 2022; however, this represents a normalization rather than expectations of future policy tightening. Meanwhile, market driven repo rates (Fig 2a) have increased due to tighter liquidity conditions ahead of quarter-end.
A solid, but still fledging recovery:
Recent economic data (Fig 3a), the first since China lifted Covid restrictions and re-opened, was solid, implying the recovery remains on track. A combination of rapid re-opening, resilient international demand and front-loaded fiscal policy support suggests the government’s modest 2023 growth target of “around 5%” remains eminently achievable. In particular, retail sales recorded a broad improvement as private consumption replaced government spending as a key growth driver, while fixed asset investments were boosted by decent manufacturing and infra-structure spending.
Nevertheless, private spending remains well below pre-Covid levels and consumer confidence is still fragile – with key automobile spending remains weak. In addition, declining export demand has dampened business activity; while land sales – a key revenue source for local governments – continues to be sluggish. Fortunately, inflation (Fig 3b) remains muted, allowing the PBoC flexibility to maintain an accommodative monetary policy.
Implications to CNY cash investment
Surprisingly buoyant global demand and a faster than expected recovery in domestic demand has boosted expectations of a strong Chinese economic recovery. Nevertheless, the strength and durability of the recovery remain uncertain, suggesting government policy is likely to stay accommodative. The PBoC’s latest RRR policy actions and promise to “promote… economic development”, should help underpin robust loan growth and support China’s continued economic recovery. Notably, the likelihood of any additional RRR or medium-term lending (MLF) cuts will be data dependent.
For CNY cash investors, the latest PBOC rate cut reaffirms that market drive interest rates are likely to remain at current low levels for the foreseeable future. Ensuring cash investments are diversified across different liquidity and ultra-short duration strategies could capture the opportunities from a still upward sloping yield curve while providing shelter from volatile market conditions and economic uncertainty.