Lower interest rates may do little to boost China's growth

Last night the People's Bank of China cut interest rates for the second time in just four weeks.

The surprise reduction is sure to stoke fears that the mainland's second-quarter economic growth rate - due to be announced next week - will be even weaker than the 7.5 per cent or so that analysts were expecting.

However, just as significant as the headline-rate cut was the asymmetric nature of the reduction. While the benchmark one-year savings rate fell by 0.25 percentage points to 3 per cent, the key lending rate was cut by a slightly larger 0.31 percentage points to 6 per cent (see the first chart).

On top of that, the central bank said that from now on banks would be allowed to make loans at rates as low as 70 per cent of the benchmark lending rate.

As a result, the minimum one-year lending rate has been reduced to just 4.2 per cent, from 5.9 per cent at the beginning of June. On paper, that exerts a painful squeeze on the margins the country's banks can expect to make between what they pay on their deposits and what they get on their loans.

Just a month ago, they were able to look forward to earning a spread of at least 2.4 percentage points between what they paid on one-year savings deposits and what they earned on one-year loans. After yesterday's cut that spread has fallen by half to just 1.2 percentage points.

In the near term that's bound to hurt the share prices of China's main banks, which have already fallen heavily since early April (see the second chart), when Premier Wen Jiabao signalled Beijing's new tougher policy stance towards the banking sector, declaring 'our banks are profiting too easily'.