China cut interest rates as part of market-oriented reform amid slowing economy

China lowered its lending reference rate through a new market-oriented pricing mechanism on Tuesday, providing a modest easing of monetary conditions to help support the world’s second largest economy amid the trade war with the United States.

The new system will enable the People’s Bank of China to lower lending rates in a flexible and frequent manner via open-market operations, offering a new tool for Beijing to manage the impact of trade tensions with the US and rate moves by the US Federal Reserve.

The new one-year loan prime rate (LPR), which is the average of the rates that 18 designated banks charge their biggest clients, was set at 4.25 per cent, according to the National Interbank Funding Centre, a unit of the People’s Bank of China (PBOC).

The new rate was lower than the previous LPR of 4.31 per cent and also lower than the old benchmark lending rate of 4.35 per cent. The LPR is the rate at which banks lend money to its best customers, based upon the rate of medium-term lending facility (MLF), which is the cost for banks to borrow from the PBOC. The five-year LPR was set at 4.85 per cent.

“The decline is not big,” said Hong Hao, managing director of Bocom International. “It’s more of a medium and long-term reform. Its short-term impact will be limited, especially when participating banks have no strong incentives to lower their rates against narrowed net interest margin.”

The lending rate mechanism change also came at a time when the US Federal Reserve is expected to cut interest rates further to prevent the US economy from falling into recession. US President Donald Trump tweeted this week that interest rates in the US should be reduced by at least a full percentage point, though the US Federal Reserve is more likely to cut by a quarter percentage point at its next meeting in September.

China did not follow the 25 basis points rate cut by the US Federal Reserve at the end of last month – the first US rate cut in more than a decade – partly because a rate cut in the official benchmark rate would have been too dramatic, but with the new mechanism, Beijing will find it easier to respond next move in September, according to Wen Bin, chief economist of China Minsheng Banking Corporation.