Investors should not expect the People’s Bank of China to introduce broad easing or massive monetary stimulus. Photo: Reuters
Opinion
Macroscope
by Hannah Anderson
Macroscope
by Hannah Anderson
China’s central bank eases into 2020 with a firm grip on loose liquidity
While policy easing remains – with falling lending rates and a cut to the reserve requirement ratio – investors should not expect a flood of liquidity. The 2020 prognosis? Loose but prudent monetary policy
Heading into the new year, I have been thinking a lot about monetary policy. The amount of liquidity provided to markets in recent years has supported higher equity valuations and kept yields low (and thus, fixed-income prices elevated). The direction that central bank policies take in 2020 is an essential consideration when making investment decisions.
All signs point to the United States Federal Reserve continuing to keep interest rates steady, with greater monetary easing from the European Central Bank and Bank of Japan. That leaves the People’s Bank of China as the only major central bank without a clearly telegraphed policy plan for 2020 for now.
It is important to note that the PBOC’s policy stance has always been clear – the techniques for executing this stance is where questions remain. Chinese authorities have consistently told markets that their policy stance is prudent with a structural easing bias. In effect, China’s central bank has been saying it will support the economy with policy easing when needed, but investors should not get carried away in expecting broad easing or massive monetary stimulus.
How the PBOC translates this stance into specific policy actions is a question I often asked myself in the later part of 2019. This last week has provided some details.
Two major developments offer concrete guidance as to how the PBOC will go about conducting monetary policy in 2020: one, the effective abolition of one benchmark set lending rate; and two, a cut to the reserve requirement ratio.
China has been reforming its interest rate system since mid-2015. The authorities have been gradually steering financial institutions away from benchmark lending rates and towards pricing their loans off of more market-based measures of financing costs. Last August, the PBOC announced a new tool called the loan prime rate. This rate is set monthly based on a survey of the loans that banks make to their best clients.
The loan prime rate has fallen gradually over the few months it has been published. In the last days of 2019, the PBOC announced that all loans made in 2020 should use the loan prime rate as their reference rate and that banks should transfer existing loans to loan prime rate referencing pricing by the end of the first quarter.
Pricing loans off of the loan prime rate will make borrowing cheaper, as this rate is lower than the overall benchmark lending rate. Transitioning borrowers and lenders to the loan prime rate also means that loan pricing will be more market-driven, a key goal of China’s interest rate reform.
On top of these changes late in 2019, the PBOC started 2020 with an announcement that it would cut the reserve requirement ratio by 50 basis points. This ratio is the level of capital that banks have to hold against loans. Cutting the reserve requirement ratio means that banks have more capital to lend.
However, China’s liquidity may not see the big boost that a 50-basis-point cut may have delivered in a different time of year. China often sees rising cash demand ahead of the Lunar New Year (which falls on January 25 this year). Additionally, local government bond issuance will be front-loaded in early 2020, raising the demand for cash.
A girl in Shijiazhuang, Hebei province, eats porridge to celebrate the Laba Festival on the eighth day of the 12th lunar month, also January 2. The festival is a prelude to the Lunar New Year, the first day of which falls on January 25 this year. Photo: Xinhua
That being said, a cut in the reserve requirement ratio is policy easing. This cut, combined with the ongoing interest rate reform, puts the PBOC’s policy stance somewhere between that of the Fed and the European Central Bank/Bank of Japan, when it comes to just how easy central banks will be in 2020.
It is only a few days into the new year but it looks like the PBOC intends to remain in this middle lane.
Chinese markets will be encouraged by the signal of continued support, but we should all recognise that large headline easing numbers, such as a 50-basis-point cut to banks’ reserve requirement ratio, do not necessarily translate into large extra amounts of liquidity. By charting a middle course, the PBOC will let other forces drive market returns over the year – forces such as business sentiment, global trade and inflation.
Hannah Anderson is a global market strategist at JP Morgan Asset Management
This article appeared in the South China Morning Post print edition as: Expect support from PBOC this year, but not with big gestures
