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US Federal Reserve chair Jerome Powell fields questions during Thursday’s news conference on interest rates. Photo: AFP

US, China economic policies like night and day as Fed pushes interest rate skyward and PBOC eyes stabilisation

  • World’s biggest economic superpowers are taking polar opposite approaches in their policy road maps, with contrasting concerns over inflation and monetary loosening
  • US Federal Reserve has announced the largest hike to benchmark interest rate in 28 years, but analysts expect China to stay the course on its easing stance

The US Federal Reserve’s largest rate hike since 1994 may have temporarily halted Beijing’s headline rate reductions, but analysts do not expect it to derail China proceeding with its easing stance and economic stimulus plan.

The policy divergence between the two biggest economic superpowers is owing to their different economic cycles, as Washington is doing all it can to curb inflation while Beijing continues to double down on stabilisation.

The People’s Bank of China, which has been closely monitoring and anticipating the moves of its US counterpart, kept the interest rate of one-year medium-term lending facility (MLF) loans unchanged at 2.85 per cent when more than 200 billion yuan (US$29.7 billion) worth of such loans were rolled over on Wednesday.

MLF loans are a key tool used by the central bank to release medium-term liquidity into the interbank market. Any cut to its interest rate would have been viewed as a clear signal to boost the economy.


US Fed raises interest rates by 0.75 percentage point, the biggest hike since 1994

US Fed raises interest rates by 0.75 percentage point, the biggest hike since 1994

China’s central bank also maintained the rate of the seven-day reverse repurchase agreement – the purchase of securities with an agreement to sell them at a higher price at a specific future date – during Thursday’s 10 billion yuan worth of sales.

The move came despite US Federal Reserve chair Jerome Powell announcing hours earlier that the US’ key lending rate would increase by 75 basis points – or three-quarters of a per cent – to a range of between 1.5 per cent and 1.75 per cent.

The biggest hike in 28 years came after the Fed made smaller hikes of 50 basis points last month and 25 basis points in March.

While balance-sheet downsizing is under way, with further hikes expected, the US central bank’s latest so-called dot plot forecast is pointing to a rate of 3.4 per cent by the end of this year, which would be higher than equivalent Chinese policy rates.

The overseas-traded yuan strengthened to 6.6658 against the US dollar, from 6.72, after the US Federal Reserve’s decision. Domestically, the Chinese currency was trading 0.4 per cent higher at 6.6950 per dollar on Thursday morning, after the government-set midpoint was raised to 6.7099 from 6.7518 a day earlier.

A lower yuan exchange rate figure means it takes fewer yuan to purchase one US dollar, indicating a stronger Chinese currency.

“The Fed tightening has certainly exerted pressure on China. For instance, the Chinese central bank has become reluctant to cut rates. But as a big country, it must insist on independent policies,” said Larry Hu, chief China economist at Macquarie Capital.

Hu also said that the country’s capital controls will remain in place to help alleviate excessive shocks to the yuan exchange rate, and that Beijing has other loosening tools.

“Chinese authorities can boost economic activities through credit expansion,” he added.

‘Important’ capital inflows for China amid growing economic pressure

Many economies took similar steps ahead of, or immediately after, the US move. The European Central Bank said a week ago that it will make its first 25-basis-point hike in 11 years next month, while Australia raised its interest rate by 50 basis points last week. Both the United Arab Emirates and Hong Kong also announced increases of 75 basis points on Thursday.
China’s relatively mild inflation – the consumer price index grew by only 2.1 per cent in May – helped justify authorities’ monetary-loosening approach.

“We must seize the window of opportunity and pay attention to macro adjustments to ensure that the economy stays in a reasonable range,” said a statement on the State Council’s website following Wednesday’s meeting chaired by Premier Li Keqiang.

That window of opportunity generally refers to the upcoming one or two quarters, as Chinese inflation is still lower than the annual control target of 3 per cent, and the China-US bond yield gap remains small.

We must not print excessive money or overdraft the future
Premier Li Keqiang

Despite the central government’s determination to stabilise the economy, with the use of “all possible tools”, Premier Li cautioned against an all-out stimulus.

“We must not print excessive money or overdraft the future,” he said at the cabinet meeting.

A higher US interest rate will generally lure more capital back from emerging markets, but this can put highly indebted economies at risk of a currency collapse or other economic turmoil.

During the previous round of US tightening from 2014-17, China saw capital flight and rapid yuan deprecation, forcing authorities to use its foreign exchange reserves and strengthen capital controls to curb outflows and stabilise the market.

Currently, the yield spread between 10-year US Treasury bills and Chinese bonds has already expanded to about 60 basis points.

China’s economic slowdown moderates in May, but ‘it will be a long haul back’

Chinese central bank data shows that overseas institutions trimmed their Chinese bond holdings by 110 billion yuan to 3.66 trillion yuan last month.

However, a net flow of 45 billion yuan into mainland China’s A-share market has been reported via the Stock Connect scheme with Hong Kong so far this month, with a total of 71.3 billion yuan in the past three months, according to Wind, a leading provider of financial information services in China.

“The net capital inflows, from merchandise trade and foreign direct investment, maintained a relatively high level. They continue to play a fundamental role in stabilising cross-border flows,” Wang Chunying, deputy head of the State Administration of Foreign Exchange, said on Wednesday.

“Unstable and uncertain external factors still exist. However, with the effectiveness of the epidemic control and economic policies, the momentum of economic recovery is accelerating, and that will help stabilise our forex market and the balance of payments.”