After US Fed’s rate hike, is China ready to embrace monetary easing measures?

Diverging monetary policies between the US and China have made Beijing wary about easing monetary operations this year, but the conditions to do so appear to be improving
It’s also possible that China’s central bank could lower the five-year loan prime rate on Tuesday, to support the property sector

China's economic recovery

Frank Tangin Beijing

Published: 7:00am, 16 Dec 2022

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A window of opportunity to implement stronger monetary policies is currently open for China after the latest moderate interest rate hike by the United States, according to analysts who are calling on Beijing to seize the chance to bolster the staggering economy amid abating spillover pressure and slowing inflation.

The US Federal Reserve announced on Thursday that it would raise its benchmark rate by 50 basis points to a targeted range of 4.25-4.5 per cent – lower than the consecutive 75-basis-point moves at each of the previous four meetings, but still bringing the rate to its highest level in 15 years.

Amid concerns over a full-blown economic recession, the Fed pointed to a “welcome reduction” in US inflation, and its dot-plot projection – reflecting estimates by the Fed’s policymakers for future interest rates – suggests that further but slower rate hikes could lift the benchmark rate to a range of 5-5.25 per cent by the end of 2023.

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Many leading Chinese investment banks have been turning more optimistic. Citic Securities said in a note that the US rate-hike cycle could come to an end around March, with the rate peaking at 5 per cent. And China Merchants Securities, citing the US fiscal burden, expected that rate cuts may start from the third quarter of next year.

They said this leaves room for China’s central bank to make bold moves, as Beijing’s priorities have turned to shoring up beleaguered expectations and revitalising economic activities.

The divergence in monetary policies between the US and China has made Beijing wary about easing its monetary operations this year.

The People’s Bank of China (PBOC) kept its policy rates unchanged on Thursday. The rate on 650 billion yuan (US$93.5 billion) worth of one-year medium-term lending facility loans remained unchanged at 2.75 per cent.

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“Given the weak economic data and the absence of inflation pressure, policymakers are set to roll out more easing measures,” said Larry Hu, chief China economist with Macquarie Group.

Despite the PBOC’s decision to keep its policy rate on hold, it’s still possible for the central bank to lower the five-year loan prime rate on Tuesday, to support the property sector, he said.

“More importantly, the PBOC could have more room to cut after February next year” if the Fed stops hiking the benchmark interest rate, he said.

Meanwhile, pressure on the yuan exchange rate, which plunged to a 14-year low of 7.2555 per US dollar in early November, has partly eased. The daily reference rate was set by the central bank at a three-month high of 6.9343 against the US dollar on Thursday.

Before any of the rate decisions this week, independent economist Ren Zeping said on Tuesday that “the window for an interest-rate cut or another cut in the reserve requirement ratio is now open” for the PBOC. The ratio dictates the amount of cash that banks must hold in reserve, rather than lend or invest.

The US tightening measures this year – raising the benchmark rate by a total of 425 basis points since March – have sparked a large capital outflow from the world’s second-largest economy and other emerging markets, as investors looked to take advantage of the stronger US dollar.

However, some overseas portfolio investments have returned in anticipation of a post-zero Covid rebound, with inflow via mainland China’s stock connect scheme with Hong Kong reaching 67.5 billion yuan (US$9.7 billion) in the past month.

Strict coronavirus controls continued to restrain China’s economic recovery before Beijing’s policy U-turn in recent weeks, with consumer inflation slowing to an eight-month low in November, the jobless rate climbing to a six-month high, and a further drop in retail sales.

Zhang Yu, chief macro analyst with Huachuang Securities, said that the weak economy may warrant a rate cut by the PBOC.

“The yield of US Treasury bills has kept sliding since November, and the yuan exchange rate has strengthened to the level of around 6.95 per US dollar. The window for an appropriate rate cut has appeared,” she wrote in a note on Tuesday.

Beijing has shifted its policy emphasis back to economic stabilisation after three years under the full force of its disruptive zero-Covid policy. The Politburo vowed in a tone-setting meeting last week to optimise pandemic-control measures and ensure that economic operations take a positive turn across the board.

Meanwhile, many analysts are expecting China to set next year’s gross domestic product (GDP) growth target at around 5 per cent, at the upcoming central economic work conference. That’s compared with a projected expansion of around 3.2 per cent in 2022.

[China’s] accommodative stance should continue with a greater reliance on cutting interest rates as opposed to channelling credit to help the economy

Gita Gopinath, IMF

But Chinese authorities still face a variety of headwinds. Despite the recent easing of the zero-Covid strategy, economic activities remain subdued and could be affected for the next one or two quarters as infections are rising significantly across the country. Consumption remains a big concern because household income has diminished over the past three years.

China also reported its worst monthly trade data in about two-and-a-half years last month, as the year-on-year export decline expanded to 8.7 per cent in November from 0.3 per cent a month earlier.

Also last month, the International Monetary Fund recommended the use of interest rate cuts and proactive fiscal support for vulnerable households to help boost the economy.

“This accommodative stance should continue with a greater reliance on cutting interest rates as opposed to channelling credit to help the economy,” its first deputy managing director, Gita Gopinath, told the Post.

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China’s central bank has cut the one-year loan prime rate, a key policy rate, twice this year, with 10-basis-point reductions in January and August. It also pumped about 500 billion yuan worth of liquidity into the interbank market by cutting the reserve requirement ratio by 25 basis points late last month.

The five-year loan prime rate, a market benchmark linked to mortgage rates, has been lowered three times, with a total reduction of 35 basis points to 4.3 per cent.

Some of the government’s stabilisation measures in recent months have started to take effect, with medium- and long-term corporate lending more than doubling last month from a year earlier to 736.7 billion yuan.

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