China: Three Rate Cuts, One Adjustment

The People's Bank of China controls several interest rates and has cut most of them by five basis points. But the maturities have all been different, meaning that we've really seen just one move to adjust the yield curve. Will there be more?

So many rate cuts but they amount to just one

The People's Bank of China has cut interest rates three times this month:

  • 5 November: One-year Medium-Term Lending Rate cut by five basis points to 3.25%.
  • 18 November: 7D reverse repo cut by five basis points to 2.50%.
  • 20 November: 1Y and 5Y Loan Prime Rate also cut by five basis points to 4.15% and 4.80%, respectively.

However, we should really see all these cuts as just one cut of five basis points. The policy implication is that the interest rate curve from the short rate to the five-year rate should reflect these cuts.

Why the PBoC needs to control so many interest rates

The methodology by the PBoC to move almost the whole interest rate curve by cutting interest rates of various maturities means that the interest rate transmission mechanism in China does not function very well.

We expect the PBoC to live with this until the MLF rate is truly market-based, at which point the PBoC can leave the MLF rate and the LPR to the market. By then, the policy interest rate will be the short-term interest rate alone.

Rate cuts will be data dependent

"Data-dependent" monetary policy is quite unusual in China because most of the time, the PBoC seems to have an interest rate path in mind for the year ahead. But the trade war has changed how the central bank projects its policy. 

A positive outcome from the trade war would mean the central bank can stay put on monetary policy, but the reverse will mean it needs to loosen further. The trade war has also resulted in massive infrastructure investments, which should enter into the production stage from the investment stage in the coming months. This will also affect how the PBoC manages monetary policy.

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