China cuts interest rates again

PBOC trimmed its 1-Year Loan Prime Rate (LPR) by 5 basis points (bp) to 3.65%. The market was anticipating a slightly larger 10 bp rate cut, following last week’s MLF decision (see below). However, the more targeted move makes sense in the context of lingering issues with policy transmission.

Meanwhile, the PBOC also trimmed the 5-Year LPR by 15 bp to 4.30%, down from 4.45%. The larger-than-expected rate cut is the second outsized move, followed another unprecedented 15 bp in May. The decision points to all eyes in Beijing now being focused on the housing sector. The 1-Year LPR is typically used to price loans while the 5-Year LPR is used as the main reference for mortgages.

Activity indicators missed expectations in July. The rebound in June was never going to be sustainable, as it predominantly reflected pent-up demand following lockdowns in several of China’s largest cities (25% of GDP) during April-May. We expect three headwinds to continue to drag on activity in Q3-22:

The balance for the month is not crystal clear. Stronger export figures exert upside risks, while activity indicators were less sanguine. We maintain our view that the economic recovery in H2-22 will be more measured, with Q3-22 remaining below trend. Therefore, it will be necessary for the authorities to take additional steps to stabilize growth.

Housing sector support measures remain targeted. Bond guarantees are a positive but no panacea. On August 19, the PBOC, housing ministry and finance ministry issued a joint statement announcing that they will offer special loans through policy banks to ensure that real estate developers are able to access working capital to deliver stalled residential projects to their rightful buyers.

On August 19, the National Association of Financial Market Institutional Investors (NAFMII), which is the interbank bond market self-regulatory body under the PBOC, also stated that it was considering potential credit guarantees to distressed real estate developers. Under a new pilot scheme, China Bond Insurance will provide bond guarantees for six developers, including: Longfor, Gemdale, Country Garden, Cifi, Seazen and Sino-Ocean.

Takeaways

These are all steps in the right direction, but they are not the panacea to resolving all housing sector ailments in China. Going forward, we expect that policymakers will continue to deploy a vast array of targeted measures. Inevitably, bank balance sheets, regional government balance sheets, central government balance sheets and household balance sheets will all have to tapped into to achieve this goal. Coordinating such a colossal policy effort takes time, while the completion of residential blocks doesn’t happen overnight either. Although we do not expect this to turn into a systemic threat, sentiment will remain fragile until an inflexion point is reached, with a bit of luck before the end of 2022.

CN: PBOC 1Y MLF 2.75% vs expected 2.85% (prior: 2.85%). The move is mostly symbolic. The PBOC cut its 1-year Medium Term Lending Facility (1Y MLF) rate and 7-day Reverse Repo Rate by a moderate 10 basis points on August 15. The move was unexpected, with most analysts predicting no changes. This is because domestic liquidity is not the issue, as demand for credit remains subdued due to weaker domestic sentiment. We therefore believe the decision is mostly a symbolic one. Lastly, with CPI now expected to breach PBOC’s 3.0% target as soon as August, it might also have boiled down to this being the last chance for PBOC to deliver that much touted rate cut.