Chinese new reference rate cut part of global trend, not a reaction to trade war pressure
China’s September loan prime rate (LPR) was lowered 5 basis points to 4.2 percent for oneyear maturities on Friday, according to the National Interbank Funding Center, a unit of the People’s Bank of China (PBC). The five-year prime rate, which is generally used as a reference for mortgages, remained unchanged at 4.85 percent.
The move marked the second reduction to the LPR since its first in August. Last month, China’s central bank rolled out the LPR mechanism as its benchmark for new loans. Under the circumstances of the current economic and financial environment, the interest rate liberalization reform is not only an important part of the financial supplyside reforms aimed at smoothing the monetary transmission channel, but also a move to bring borrowing costs down gradually. Given the recent, sluggish economic data, the central bank clearly wants to guide market interest rates lower to boost the economy, but it doesn’t want the adjustment process to be so dramatic as to change market expectations and cause unwanted side effects.
Some attributed the lowered LPR to the easing trade war pressure, which seems like nothing but a far-fetched interpretation. While changeable trade tussles have led to frequent shifts in financial markets’ expectations of the economy, the current trade problem is far from affecting China’s monetary policy, which usually sets the tone for the entirety of a fundamental economy.
As such, China’s latest minor cut to its LPR are more likely in line with the global trend of monetary easing. Specifically, on September 12, the European Central Bank slashed its benchmark interest rates to minus 0.5 percent and launched a large-scale bond-purchasing program at the same time, marking the restart of quantitative easing in the region. Then, on September 18, the Federal Reserve cut its key interest rates by 25 basis points, the second cut following that of July. After the Fed’s second rate slash, central banks in Brazil, Saudi Arabia, Jordan, Indonesia, Qatar and other countries around the world quickly followed suit, joining in the monetary easing.
Against a backdrop of the global trend of quantitative easing, it is not surprising to see the PBC also lower market rates by cutting the LPR. Yet, under the new LPR mechanism, the downward adjustment of banks’ lending rates will be a gradual process, which may not see significant impact in the short term. At present, the new reference rate is only applied to a part of new loans by commercial banks, while the previous benchmark lending rate will still apply to older loans like mortgages. And since the LPR is the most preferential lending rate offered to a bank’s prime clients, the impact of its cut will be much slower and weaker compared with a direct reduction to the previous benchmark lending rate.
Such a slow and gradual process of bringing borrowing costs down may be exactly what the Chinese central bank wants to achieve, which is conducive to avoiding drastic changes in market expectations or avoiding excess liquidity in some sectors like the property market.
It should be acknowledged that loosening monetary policy is a necessary move to support the economy under the current external and internal economic environment, but stabilizing the growth or the overall situation should be the top priority currently. It is essential to maintain a balance between different policy tools, and therefore a minor and gradual adjustment through the LPR seems more flexible and practical for the current situation.
Besides, the LPR, which is set by 18 commercial banks and is loosely pegged to the rate on the medium-term lending facility, is also the first step in interest rate liberalization reform. Since it is a systemic reform related to the pricing system in the financial market, it may also face a series of risks such as business and moral risks in financial institutions, liquidity risk in financial markets, credit risk in the property sector, and debt risk in local governments. In this sense, the interest rate liberalization reform still has a long way to go, and more efforts are needed to enhance financial supply-side reforms.