China’s monetary policy loosening is a sign that the central bank is gearing up for a fight

The People’s Bank of China’s decision to cut the reserve requirement ratio by 50 basis points suggests the central bank has finally started to fine-tune monetary policy in response to growing pressure on the economy and rising risks to financial stability.

The reserve requirement ratio cut will release around 700 billion yuan (US$105.1 billion) of liquidity into the banking system. While the size of the cut was half of that in April, the net liquidity injection will be almost twice as large, as the previous reduction was used partly to offset the maturity of the central bank’s medium-term lending facility loans.

The latest cut sends a much clearer signal that the central bank is prepared to safeguard the economy against rising internal and external risks. This is curiously reflected in the timing of both the announcement on June 24 – merely one week after the soft economic activity data in May – and its implementation on July 5, one day before the first batch of US tariffs is supposed to go into effect.

Fundamentally, some monetary easing is warranted at the moment, as the overall conditions in China have become suffocating for growth. The tightening effect of deleveraging and new asset management rules have led to a persistent decline in the growth of M2, a broad measure of money supply, while the shrinking of shadow banking credit has driven down total social financing.