China Cuts Benchmark Lending Rate, but Leaves Five-Year Rate Unchanged Amid Currency Concerns
SHANGHAI/SINGAPORE, Aug 21 (Reuters) – China has reduced its one-year benchmark lending rate in an effort to stimulate credit demand and boost its slowing economy. However, the country surprised markets by keeping the five-year rate unchanged, raising concerns about the weakening currency.
China’s economy, the second-largest in the world, has been struggling due to a property slump, weak consumer spending, and tumbling credit growth. These factors have led authorities to consider implementing more policy stimulus.
Analysts believe that the downward pressure on the yuan has limited China’s ability to implement deeper monetary easing. An increase in China’s yield differentials with other major economies could potentially trigger a selloff of the yuan and capital flight.
The one-year loan prime rate (LPR) was cut by 10 basis points to 3.45%, while the five-year LPR remained at 4.20%. A Reuters poll of 35 market watchers had predicted cuts to both rates, but the reduction in the one-year rate was smaller than expected.
“Probably China limited the size and scope of rate cuts because they are concerned about downward pressure on the yuan,” said Masayuki Kichikawa, chief macro strategist at Sumitomo Mitsui DS Asset Management. “Chinese authorities care about currency market stability.”
Most new and outstanding loans in China are based on the one-year LPR, while the five-year rate influences the pricing of mortgages. Both LPRs were cut in June as part of efforts to boost the economy.
The yuan has weakened nearly 6% against the dollar this year, making it one of the worst performing Asian currencies.
The decision to keep the five-year rate unchanged caught many traders and analysts off guard. Some expected deeper cuts to the benchmarks due to the troubled property sector and rising default risks at some developers.
“We interpret the status quo of the five-year LPR as a signal that Chinese banks are reluctant to cut rates at the expense of rate differential margin,” said Ken Cheung, chief Asian FX strategist at Mizuho Bank. “It flagged a problem on the effectiveness of PBOC’s policy guidance pass-through into the market, and the Chinese authorities may be lacking effective tools to stimulate the property sector and economy via monetary easing.”
Cheung added that the unexpected rate outcome may be negative for China’s growth outlook and the yuan exchange rate.
The People’s Bank of China (PBOC) announced last week that it had unexpectedly lowered its medium-term policy rate. The medium-term lending facility (MLF) rate serves as a guide to the LPR and is seen as a precursor to future changes in the lending benchmarks.
China’s central bank has pledged to keep liquidity reasonably ample and implement “precise and forceful” policies to support the economic recovery. However, the steady five-year rate has raised questions about the effectiveness of these measures.
The central bank has also stated that it will optimize credit policies for the property sector and coordinate financial support to resolve local government debt problems.
Reporting by Winni Zhou and Tom Westbrook; Additional reporting by Kevin Buckland; Editing by Sam Holmes
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