By Win Thin
People’s Bank of China today cut the 1-year lending rate by 31 bp to 6% and the 1-year deposit rate by 25 bp to 3%. It also widened the allowable discount that commercial banks can offer on loans from 20% to 30%. This gives the PBOC rate cut more bang for the buck, as banks can cut their loan rates by even more than the PBOC’s 25 bp cut. There was no change to reserve requirements, as one newswire erroneously reported. After PBOC started the cycle back in December with a 50 bp cut in the reserve requirement to 21%, it followed up with another 50 bp in February and another 50 bp in May to 20% currently. Today’s rate cut follows the first outright rate cut in this easing cycle back on June 7, and so we think this recent change in pace marks the beginning of the more aggressive easing cycle that we have long been expecting.
Trying to figure out the timing is, as always, pure guesswork, but we fully expect more easing measures in the coming months. To give a scale of comparison, we look at the aggressive easing phase seen from September-December 2008. Over those four months, reserve requirements were cut 200 bp and lending rates were cut 216 bp. So far during this current cycle, reserve requirements have been cut 150 bp and lending rates 56 bp. Back then, China’s fiscal stimulus ended up being the largest in the world as a share of GDP. However, officials have taken pains to tell markets not to expect the same scale of overall stimulus as was seen during the 2008-2009 downturn. GDP growth slowed from double digits in 2007 and H1 2008 to a cycle low of 6.2% y/y in Q1 09 before accelerating back to double digits in Q4 2009 in response to stimulus. Consensus for Q2 GDP growth is 7.8% y/y vs. 8.1% y/y in Q1. Looking ahead, consensus sees growth picking up to 8.3% y/y in Q3 and 8.5% y/y in Q4, implying an annual rate of 8.2% in 2012. All of this seems too optimistic given the global backdrop, and we think growth will likely slow in Q3 and perhaps even in Q4 before stabilizing.
This latest easing move comes ahead of the June data deluge that starts on Monday with the release of CPI and PPI. CPI consensus is at 2.3% y/y vs. 3.0% y/y in May. Trade data is due out on Tuesday, with consensus for a $23.5 bln surplus and export growth slowing to 10.6% y/y from 15.3% y/y in May. Given other weak EM trade data already reported for June, a drop-off in China seems very likely at this juncture. IP, retail sales, and Q2 GDP are all due out on Friday. Consensus is for a slight pickup in IP to 9.9% y/y in June from 9.6% y/y in May, but PMI readings suggest otherwise. HSBC and official China PMI for June have already come out, with the former falling to 48.2 from 48.4 in May and the latter falling to 50.2 from 50.4 in May. New loan and money supply data are due out next week but there is no specified date yet. Market consensus is for new loans of CNY890 bln vs. CNY793 bln in May, though new lending is a very volatile number month to month. We feel that the rate cut today suggests that much of the data is likely to come in on the soft side, and we think the downturn is becoming more severe.
It’s early in the quarter, but spot CNY is basically flat QTD after weakening 0.9% vs. USD in Q2, the biggest quarterly depreciation since the strict dollar peg ended in 2005. We think spot CNY will be kept basically steady in Q3 and Q4. During the 2008-2009 downturn, spot CNY was kept basically stable from mid-2008. CNY only saw one down quarter (Q1 2009) and even then it was only down 0.1%. We do not think China is embarking on a campaign of significant nominal depreciation now, and expect the recent bout of depreciation to be limited and perhaps even partially reversed. We note that spot CNY appreciation did not resume until mid-2010, well after the Chinese economy had turned around (as noted earlier, the trough for GDP was 6.2% y/y in Q1 2009). As such, there is a risk that the current period of no CNY spot appreciation may go on longer than the market is anticipating.