-Benchmark rate cut surprises the market, but suggests May data was even weaker than Aprils
-PBOC announces significant move to increase banks flexibility to price funds against the benchmark
-These changes should spur growth, add to mild CNY weakness, and damage banks’ profitability
-We adjust our forecasts to look for two more 25bps cuts in the benchmark rates in H2-2012
The Peoples Bank of China (PBoC) has announced two big adjustments in its interest-rate policy:
Benchmark interest-rate cuts: lending rates were cut by 25bps for all tenors; saving rates were cut between 10bps and 40bps for different tenors, by more at the longer tenors, with the 1Y saving rate being cut by 25bps (the same scale as the 1Y lending rate). From 8 June, the 1Y loan rate will be 6.31%, the 1Y deposit rate 3.25%.
More flexibility for banks to set rates around the benchmark rates:This marks a significant step forward in interest-rate reform. In the past,banks were not allowed to (officially) offer saving rates higher than the benchmark rate (though wealth management products allow a way around this limitation, see On the Ground, February 22, ‘China – Spreading the wealth’). Now banks are allowed to offer saving rates up to 1.1x the benchmark rate. On the lending side, banks may now offer up to a 20% discount on the benchmark rate, compared with a 10% discount in the past.
We now forecast that the PBoC will reduce interest rates two more times in 2012, by 25bps each time (for 1Y benchmark rates). Our view is driven by an assumption of further weakness appearing in the May-July economic data, and continued difficulties in the euro area.
The interest-rate cuts surprised the market – and are a big, public signal that Beijing has moved to a pro-growth stance (even after not changing official monetary policy in the last State Council statement, see On the Ground, May 28, 2012, ‘The 2012-13 mini-me stimulus’). Most analysts (including ourselves) were expecting more reserve requirement ratio (RRR) cuts before any move to cut benchmark interest rates. De facto borrowing costs have been falling in the past few weeks as cheaper inter-bank funding has filtered through to corporate loan pricing by the banks. We have already been seeing many more banks lending 6M money at „PBoC benchmark minus 10%‟, which entails a substantial saving compared to in Q1, when banks were mostly lending at the PBoC benchmark or above it.
The increased flexibility for banks to decide on actual loan and deposit rates suggests that after much internal debate, the PBoC wants to move forward with interest-rate reform (see The Renminbi Insider, September 20, 2011). There has been discussion of an asymmetric rate cut – cutting loan rates but keeping deposit rates flat. What happened is much more significant.
The new rate environment