China reaction: Surprising second rate cut in a week

The busy week for PBoC

On Monday, the PBoC cut the 7-day reverse repo rate by 10bps, aligning with the 3rd Plenum’s emphasis on economic growth and the new policy rate framework announced by PBoC Governor Pan Gongsheng in late June. Shortly after, the market rates Loan Prime Rate (LPR) for 1-year and 5-year were reduced by 10bps, to 3.35% and 3.85%, respectively.

Following Monday's unexpected move, the PBoC surprised the market again this morning with a 20bps cut to the 1-year MLF rate, reducing it to 2.3%. They also injected RMB 200bn via MLF facilities, marking the first positive monthly net injection (RMB 197bn) since February this year. This ad-hoc MLF injection is the second operation of the month, following the usual mid-month operation on July 15, which net withdrew RMB 3bn of liquidity without a rate cut.

It is rare for the PBoC to act so quickly and frequently, especially given their goals of stabilising net interest margins and managing depreciation pressure on the RMB. This unexpected cut ahead of the Federal Reserve's expected easing reflects concerns over disappointing Q2 GDP growth (4.3% year-on-year, 0.5% quarter-on-quarter), weak credit demand in recent months, the reiteration on the pro-growth agenda during the 3rd Plenum and still low rates of Consumer Price Index (CPI) inflation.

After Monday's 7-day reverse repo rate cut, the market anticipated a MLF cut in mid-August, following the usual MLF operation schedule. However, the central bank has acted sooner. Two MLF operations in a month are unusual; the last instance occurred in November 2020 during a credit crisis triggered by the default of a AAA-rated State-Owned Enterprise (SOE), Yongcheng Coal and Electricity.

In the current low-inflation environment, China's real interest rate remains elevated, hindering credit demand and dragging economic growth. This week's actions from the PBoC point monetary policy in an easing direction, which is welcomed by both the market and the economy. It also reveals the pressure to achieve growth targets in the second half of the year and the PBoC's dedication to doing so. Interestingly, these easings have occurred against a backdrop of a firmer yuan against the US dollar, with the yuan firming further after today’s move.