China Unexpectedly Cuts One-Year Policy Rate by Most Since 2020

The People's Bank of China (PBOC) unexpectedly lowered the cost of its one-year policy loans by 20 basis points, marking the most significant reduction since April 2020. This decision came just days after cutting a key short-term rate, signaling increased support for a slowing economy [para. 1]. The central bank decreased the medium-term lending facility (MLF) rate to 2.3%, the first reduction in almost a year [para. 2]. This move followed the PBOC's earlier cut of the seven-day reverse repo rate by 10 basis points. Such coordinated effort across key interest rates aims to ease monetary policy, with the seven-day reverse repo possibly becoming the main policy rate [para. 3].

China's bond futures and the yuan saw modest gains following the rate cut [para. 4]. The decision underscores the urgency to support growth, which was worse than expected in Q2 due to weak consumer spending despite robust exports [para. 6]. The timing was unexpected as the PBOC usually conducts MLF operations mid-month and had already drained a net 3 billion yuan of cash earlier in the month [para. 7]. On the day of the announcement, the PBOC provided 200 billion yuan of MLF, the largest net injection since January [para. 8].

Switching to the seven-day reverse repo as the primary rate could allow the PBOC to better influence the market by sending clearer signals and managing borrowing costs more effectively [para. 9]. However, economists believe the current rate cuts are modest and unlikely to significantly boost domestic demand without an improvement in the jobs market [para. 10]. Michelle Lam, an economist at Societe Generale SA, indicated that the cuts are still not enough to alter weak job and income expectations, and the MLF rate remains high compared to market rates [para. 11]. Banks have shown little interest in MLF funds recently, preferring cheaper market rates over borrowing from the PBOC [para. 13]. The one-year negotiable certificates of deposit rate issued by top-rated banks is currently at 1.9%, cheaper than the MLF funds [para. 14].

The sudden announcement might also cause confusion regarding the PBOC's policy schedule, making liquidity management more challenging for banks if MLF operations are moved from the 15th to the 25th of each month [para. 15]. Earlier, China's largest state banks reduced rates on some deposit products, aiming to manage profit margins following cuts to the loan prime rates [para. 18]. Economists narrowly predict further bank lending rate cuts in Q4, with projections of a 10 basis points or more reduction in the one-year LPR [para. 19]. According to Bloomberg economists, the PBOC’s unscheduled action along with positive signs from the Third Plenum, and the weakness of the dollar, show a collective effort to boost the economic recovery [para. 20].

In a separate disclosure, the PBOC stated that banks utilized only 12 billion yuan out of a 300 billion-yuan quota for an affordable housing program up to June. This program aims to provide cheap funding for lenders that issue credit to local governments to buy unsold homes and convert them into subsidized housing [para. 22]. Despite being part of a broader property rescue package unveiled in May, it has yet to make a significant impact on reversing declining home prices [para. 23].