China’s central bank cut its key interest rate for the first time in almost two years to help bolster an economy that’s lost momentum because of a property slump and repeated virus outbreaks.

In a stark policy divergence with other major economies, the People’s Bank of China lowered the rate at which it provides one-year loans to banks by 10 basis points -- the first reduction since April 2020.
 

CENTRAL BANK WATCH

While inflation is the dominant concern for central bankers in the U.S. and Europe, China’s relatively stable prices mean policy makers have shifted to boosting growth. Official data Monday showed gross domestic product rose four per cent last quarter from a year earlier, the weakest since early 2020.

The rate cut is part of Beijing’s efforts to put a floor under growth in a crucial year of leadership transition for the world’s second-largest economy. The biggest challenges to meeting that goal are sporadic outbreaks of the more-infectious omicron coronavirus variant, and continued falls in property sales reducing housing investment.
 

ECONOMIC SLOWDOWN

Housing sales remained low in December, while consumer spending slowed sharply as the government tightened virus controls. An outbreak of omicron-variant virus cases in January, including in Beijing over the weekend, will further curb sentiment.

“Consumption remains the weakest link in China’s growth story at the moment and that will by and large continue for much of this year,” said Louis Kuijs, head of Asia economics at Oxford Economics. “We think Beijing has a bottom line of around five per cent. As is the case at the moment, if growth is weaker than that, they’d feel strongly motivated to pursue more policy easing.”
 

RATE CUT

Economists expect more policy action from the PBOC in coming months. Goldman Sachs Group Inc. said there’s a possibility the central bank will allow banks to lower the five-year loan prime rate, a reference for mortgages, on Thursday. The one-year rate was already cut in December. Economists at Australia & New Zealand Banking Group and BNP Paribas see the likelihood of further reductions in the reserve requirement ratio for banks.  

For the full year, China’s economy expanded 8.1 per cent, well above the government’s target of “over six per cent,” due in part to the low base of growth in 2020. Last year Beijing took advantage of that as well as strong overseas demand, to try and remake its economy: reining in large technology platform companies and trying to squeeze financing to real-estate companies to reduce the economy’s reliance on property development, which accounts for as much as 20 per cent of GDP.

The financing squeeze led to a 11.4 per cent fall in the area of new projects started by real-estate developers last year, dragging down production of commodities like steel and cement. Property investment dropped 14 per cent in December from a year earlier, according to Bloomberg calculations based on full-year government figures.

“The property sector’s drag on fixed asset investment is quite stark and shocking,” said Liu Peiqian, China economist at NatWest Group Plc.

Key Data Highlights

• Industrial output rose 4.3 per cent y/y in December, versus the median forecast of 3.7 per cent. For the full year, it went up 9.6 per cent
• Retail sales increased 1.7 per cent y/y in December from 3.9 per cent in November and versus an estimate of 3.8 per cent. Total sales rose 12.5 per cent in the year
• Fixed-asset investment rose 4.9 per cent y/y in 2021. Property investment was up 4.4 per cent, infrastructure investment gained 0.4 per centand spending in the manufacturing sector climbed 13.5 per cent
• The jobless rate rose to 5.1 per cent at the end of December from five per cent in the previous month
• The economy expanded 1.6 per cent on a quarter-on-quarter basis in the final three months of the year, faster than a revised 0.7 per cent in the previous three months

Consumption returned to growth after a historic decline in 2020, and accounted for the bulk of last year’s economic expansion, although the pace of consumer spending growth was below pre-pandemic levels. The record trade surplus of US$676 billion last year accounted for about one fifth of full-year growth.

Along with the rate cut, the PBOC also injected more liquidity by offering 700 billion yuan (US$110 billion) of one-year loans, exceeding the 500 billion yuan maturing, and added 100 billion yuan with seven-day reverse repos, more than the 10 billion due. The bank also lowered its seven-day reverse repurchase rate to 2.1 per cent from 2.2 per cent.

What Bloomberg Economics says...
The People’s Bank of China’s bigger-than-expected cut to the one-year medium-term lending facility rate shows it’s serious about putting a prop under the economy. The move suggests banks will quote a lower one-year Loan Prime Rate at Thursday’s fixing for a second month in a row -- providing more support for a slowing economy.

Chang Shu and David Qu

Chinese stocks rose following the rate cuts, with the benchmark CSI 300 Index up as much as one per cent after falling in the previous two days. The yield on 10-year sovereign bonds trimmed its drop to 1 basis point to 2.78 per cent as of 2:10 p.m. local time, after falling three basis points in response to the rate reductions.

The interest rate cuts were the latest in a string of growth-supporting moves by Beijing. Policy makers have stepped up the issuance of bonds used by local governments to fund infrastructure, and told banks to accelerate lending to property companies to reduce the risk of a hard landing for the housing market.

Bruce Pang, head of macro and strategy research at China Renaissance Securities Hong Kong, forecasts the PBOC will cut the reserve requirement ratio for banks by 100 basis points this year, but sees no more rate cuts unless economic growth significantly lags expectations.

“The interest rate cut has laid a good foundation ahead of the Lunar New Year to stabilize expectations, but going forward it will require the combination of fiscal, industrial and employment policies to boost growth,” he said.