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China Cuts Interest Rates to Boost Economy

The People's Bank of China have announced a small cut to interest rates. This move is seen by economists as a sign the authorities are still working hard to pull the economy out of a slump.

What Cuts Have Been Made?

The new lending rates in China saw a five basis point drop on the one-year loan prime rate (LPR), from the previous figure of 4.20% to 4.15%. The five-year LPR rate was reduced from 4.85% to 4.8%. The LRP was only introduced in August of this year as a new benchmark that may eventually replace the fixed lending rate that is currently used.  

While these rate cuts are modest in size, it is believed that more cuts may follow if they don’t have the desired effect.  The challenge for the Asian giant is to get their economy back on track while keeping inflation under control.

This decision came shortly after the Chinese central bank had lowered the seven-day reverse repurchase rate for the first time in over four years. This is a short-term rate that determines how the People’s Bank of China lends to commercial lenders. It dropped by five basis points, taking it down to 2.5%.

An earlier decision has also seen the one-year medium term lending facility (known as MLF) cut by five basis points, taking it to 3.25%. This is the rate that banks take into account for longer-term loans.

What Was the Reaction?

The initial reaction to the rate cut wasn’t particularly positive. Investors in China and the rest of Asia appeared to remain concerned, with the ongoing trade dispute with the US still a major concern. This has also led to international debt recovery becoming an important topic among businesses.

The Shanghai Composite Index in China fell by 0.6%. Meanwhile, in Hong Kong the Hang Seng Index was down by 0.7%. The same trend appeared in Japan and South Korea. The Nikkei dropped by 0.6% and the KOSPI by 1.1%.

What Can We Expect to Happen Now?

The damaging trade war between China and the US has coincided with lower domestic demand. The third quarter of 2019 saw the gross domestic product of the Asian powerhouse grow by 6%, which was as low as it has been in almost 30 years.
Other economic data coming out of China show that the economic slowdown is continuing. These include retail sales growing less than expected, with 7.2% growth compared to the 7.9% level that had been predicted. Weak industrial output numbers also disappointed, with just 4.7% growth.

The most recent monetary report talks of downward pressure that has “continued to increase in the economy”. They also pointed out that “weakening external demand” is having an impact on the country’s exports.

Yi Gang is the PBOC governor. He was quoted recently as saying that the Chinese central bank needs to adjust their policy in order to "strengthen its counter-cyclical adjustments".

While many analysts expect further rate cuts in the near future, the risk of inflation getting out of control means that it is a difficult balancing act for the policy-makers to maintain.