China follows US Fed by raising money market rates
The last hike was in March, when the People’s Bank of China responded to a similar move across the Pacific
China’s central bank raised its interbank policy rates by 5 basis points on Thursday, hours after the US Federal Reserve lifted the US benchmark, signalling that Beijing is watching policy moves across the Pacific and is ready to contain capital outflow risks.
The People’s Bank of China (PBOC) has been putting on a brave face about interest rate rises in the US and has kept its benchmark deposit or saving rates, the most important in China, unchanged for more than two years under a “prudent” monetary policy stance.
But on Thursday, China’s central bank raised the seven-day reverse repo rate to 2.5 per cent and the 28-day reverse repo rate to 2.8 per cent. At the same time, it also raised rate for one-year medium-term lending facilities, another liquidity management tool, by 5 basis points to 3.25 per cent, according to an online statement.
While such rates in the interbank market are not China’s benchmark policy rates, they are controlled by the central bank and serve as quasi policy rates in open market operations. By raising the rates, the central bank is charging banks a higher price on loans.
It is the first rise of its kind since March, when the PBOC responded to a similar move across the Pacific, but it was smaller than the March increase of 10 basis points. When the Fed raised rates in June, China did nothing.
Former PBOC economist Ma Jun said China’s move on Thursday was symbolic rather a serious step to raise rates.
“It sends a message to the international market that China cares about monetary policy coordination and stabilising the interest rate gap between China and the US,” Xinhua quoted Ma as saying.
The 5 basis points increase also “sends a warning to overseas speculators who are trying to short the yuan” because it showed the PBOC could act to discourage capital outflows, he said.
China grappled with capital outflows and yuan depreciation in the second half of 2015 and last year after missteps in adjusting the yuan exchange rate. Those difficulties were exacerbated by a hawkish Fed, with a higher US dollar threatening to lure more money from China.
But China could not afford to raise interest rates dramatically for fear of introducing fresh risks to its debt-ridden economy.
Hong Hao, chief strategist at Bocom International in Hong Kong, said the PBOC opted to adjust the interbank policy bank rate because an increase in deposit or lending rates would have been too dramatic.
“It’s hard for China to touch benchmark rates because it conveys a strong signal [of policy tightening],” Hong said. “But the move showed the government’s intention to maintain a neutral … liquidity environment.”
The central bank tried to play down the move on Thursday, saying the modest increase was more of a market response to the Fed’s decision instead of a central bank manoeuvre.
“The small rise in the interbank policy rate will help narrow the gap with the market rates, change market distortions and improve monetary policy mechanisms,” the PBOC said.
Wu Qi, a fellow at the Beijing-based Pangoal Institution, a private think tank, said Beijing was taking a precautionary stance in the face of the Fed’s balance sheet reductions, US President Donald Trump’s tax cut bill, and the anticipated interest rate increases.
“The US tax cut in particular is starting a global competition which may weigh on China in terms of capital flight and the value of the yuan,” Wu said.
Chinese President Xi Jinping will convene an annual economic policymaking meeting next week in Beijing, with the focus on preventing financial risks.
The Fed’s interest rate trajectory, which is expected to include three rate rises in 2018 on top of the three this year, will be a key external factor influencing China’s financial dangers.
Morgan Stanley said China might have to follow the Fed to raise its benchmark interest rates in the third quarter of next year and the first quarter of 2019.
“The real lending rate has reached historically low levels and the real deposit rate has fallen to negative territory … approaching the threshold that we see for a first rate hike," Morgan Stanley chief China economist Robin Xing wrote in a research note earlier this week.
China’s one-year benchmark rate is at a historically low 1.5 per cent, but the market rates, as seen from the interbank offered rates in Shanghai, have largely stayed above 3 per cent.
Moody’s Asia-Pacific chief credit officer Michael Taylor said the PBOC had more autonomy in terms of monetary policy and did not have to follow the Fed.
“As long as the current capital controls stay in place, I wouldn’t anticipate the capital outflows are going to accelerate significantly next year,” he said on Tuesday.
“Fed tightening should not really have that big an impact on China. China’s financial system is still fairly closed off from what happens in the rest of the world.”