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China economy

Fed rate increase limits China’s central bank’s ability to help struggling economy battling US trade tensions

  • A cut in benchmark interest rates could have put significant downward pressure on the yuan exchange rate
  • The People’s Bank of China did announce a modest Targeted Medium-Term Lending Facility rate cut just hours before the US Federal Reserve raised its borrowing costs
PUBLISHED : Thursday, 20 December, 2018, 5:44pm
UPDATED : Thursday, 20 December, 2018, 5:46pm

China’s central bank is once again hemmed in by higher interest rates in the United States, limiting its ability to ease monetary policy to support a slowing domestic economy, analysts said.

Nevertheless, The People’s Bank of China (PBOC) did not sit idly by, announcing a modestly lower interest rate for a new lending tool that it unveiled just hours before the US Federal Reserve announced its rate increase.

Despite recent volatility in stock markets and signs of slowing global growth, the US Federal Reserve went ahead on Wednesday and raised its target for the federal funds rate by a quarter of a percentage point to a range of 2.25 per cent and 2.50 per cent.

While it lowered its projection of further rate increases to two from three in 2019, the Fed comments in general were not as dovish as the market had hoped for, with the central bank’s statement highlighted the strengthening of the US labour market as well as household spending.

In contrast, the PBOC unexpectedly launched a new Targeted Medium-Term Lending Facility (TMLF) policy tool to provide low cost funds to commercial banks to promote more lending.

The PBOC also increased banks’ quotas for lending to small companies and private enterprises by 100 billion yuan (US$14.5 billion) to further stimulate loan activity.

The TMLF, through which banks can borrow funds for up to three years, charges an interest rate of 3.15 per cent or 15 basis points lower than the PBOC’s ordinary lending facility.

The market interpreted the lower bank funding costs as a rate cut, signalling a modest monetary policy easing step even though the PBOC has repeatedly said its policy stance is prudent and neutral.

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Nevertheless, the fact that the PBOC stopped short of a broader easing and also limited the new TMLF to qualified banks with the proceeds targeted at small private firms, it shows the current constrains on the PBOC, analysts said.

Any outright cut in the PBOC’s benchmark interest rates would have resulted in a significant monetary policy divergence with the Fed that could have exerted significant depreciation pressure on the value of the yuan exchange rate, analysts said.

The yuan has dropped 5.7 per cent against the US dollar this year partly because investors have diverted money into US dollar denominated assets that generate higher returns.

“There seems to be significant determination to maintain currency stability because of the ongoing trade negotiations and concerns about the effects on the financial markets and economy,” said Yu Song, chief China economist at Goldman Sachs.

“Lowering interbank interest rates would put additional pressure on the currency. Therefore, [the new TMLF] is likely a small additional loosening measure.”

Margaret Yang, market analyst at online currency broker CMC Markets, said Chinese authorities were also refraining from massive policy stimulus to keep a lid on overall debt levels that could make the economy vulnerable in the longer term.

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“Targeted monetary easing served as a signal that policymakers are trying to strike a balance between supporting [small and medium-sized enterprises] and preventing a broad base rate cut that adds to debt problems,” she said.

While the PBOC’s move could boost market sentiment, it is far from enough to stop the ongoing growth slowdown, analysts agreed.

The official purchasing managers’ index showed that the Chinese economy slowed further in November, leaving the manufacturing sector on the brink of contraction.

The official composite purchasing managers’ index fell to 52.8 in November, the lowest since the composite series began in January 2017, and from 53.1 in October.

And the growth rate of outstanding total social financing, a broad measure of liquidity and credit in the economy, slowed to a new all-time low of 9.9 per cent last month from 10.2 per cent in October.

The ongoing trade tensions between the United States and China are making the outlook for China’s economy especially murky even if there were some signs of goodwill from both sides, said Thomas Costerg, senior US economist at Pictet Wealth Management.

China’s Sinograin, for example, said on Thursday it had recently bought a few batches of soybeans from the United States.

Expectations are rising for a mini trade deal before the March 1 deadline set by the US, but risks still remain.

“Long-term thorny issues, such as China’s economic and technological rise are unlikely to find an easy resolution. These structural concerns could come back and haunt any ‘truce’,” Costerg warned.

“Geopolitical frictions could reverberate on the economics.”

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Larry Hu, economist at Macquarie Capital, said that the PBOC’s move was far from enough to stop the ongoing growth slowdown.

Hu noted that the price of steel, which is a proxy for economic activity, has fallen 13 per cent since late August.

“Having slowed for the past four quarters, the Chinese economy is only halfway through the current down-cycle,” Hu predicted, suggesting 2019 would be another difficult year.