China surprises with unexpected rate cuts: A signal for economic stimulus

In a surprising move to strengthen the world's second-largest economy, China has unexpectedly announced interest rate cuts just days after a crucial meeting of the Communist Party. On Monday, the People's Bank of China (PBoC) announced that the one-year loan prime rate for business loans would be cut by 0.1 percentage points to 3.35 percent, marking the first such reduction since last August. The five-year loan prime rate, which influences mortgage rates, was also cut by 0.1 percentage points to 3.85 percent, the first reduction since February. These measures followed a reduction in the so-called reverse repo rate, a seven-day rate used for short-term loan pricing, also by 0.1 percentage points to 1.7 percent. The PBoC stated that this move was intended to "enhance countercyclical adjustments and better support the real economy." China has repeatedly lowered its key lending rates in recent years against the backdrop of a persistent property market slump and weak domestic demand. Policymakers are under pressure to take more substantial measures to boost investor and consumer confidence. Official data from last week showed that the economy grew by 4.7 percent in the second quarter, missing forecasts, while real estate sector indicators deteriorated. Eswar Prasad, an economics professor at Cornell University, said these quantitatively modest but symbolically significant measures indicated the government's willingness to finally employ macroeconomic incentives to support weakening economic activity. The interest rate cuts followed the third plenum of the Communist Party of China, a highly confidential meeting where the elite of the Central Committee sets its political direction. At this year's event, which ended on Thursday, officials expressed concern about the economy and promised additional support. Beijing has allowed state-owned enterprises to purchase unsold apartments in recent months to address the property market slump. However, there are few signs of improvement in this sector, as new home prices fell by 4.5 percent last month, the sharpest decline in nearly a decade. China's interest rate policy has significantly evolved in recent years, with rates like the LPR tied to a medium-term lending facility set by the PBoC, which influences the banking sector's liquidity. In June, Pan Gongsheng, the governor of the central bank, hinted that the repo rate might play a larger role in policy setting in the future. Lynn Song, chief economist for Greater China at ING, said the rate cuts announced on Monday could be seen as a signal that the seven-day reverse repo rate is now taking on the status of the primary policy rate, depending on whether other key rates would also be cut in the coming weeks. However, analysts warned that the impact of such rate cuts would likely be moderate. Prasad said that the LPR cuts are "unlikely to be effective" unless they are accompanied by fiscal incentives and more comprehensive policy reforms to revive private sector confidence. Julian Evans-Pritchard, head of China Economics at Capital Economics, added: "If the PBoC is serious about stimulating the economy, it should cut rates much more aggressively. Still, large-scale rate cuts seem unlikely due to efforts to stabilize long-term yields and keep currency depreciation in check." The yield on China's ten-year government bond fell to 2.24 percent on Monday following the rate cut, while the renminbi dropped to a nearly two-week low of 7.28 per dollar.