The People’s Bank of China (PBoC) today cut the reserve requirement ratio (RRR) for commercial banks by 50bp effective from 5 February. For the largest bank the RRR will fall from 20.0% to 19.5%. The cut can hardly be regarded as a big surprise. The PBoC cut its leading interest rates in November and signalled that China had entered an easing cycle; since then financial markets have been waiting for more easing. If anything, the PBoC has been more cautious than expected.
Nonetheless, today’s cut in the RRR is very important and positive for the global economy. First, it underscores that the PBoC now has a substantial easing bias after some doubt had started to creep into financial markets. Second, a cut in the RRR is more important than cutting the leading interest rates, in our view. Because of interest rate liberalisation, the leading interest rates have become largely symbolic and the interest rate cut in November did not have a substantial impact on the important interest rate in the interbank market. A cut in the reserve requirement will inject liquidity into the interbank market, putting more direct downward pressure on interbank interest rates, unlike the largely symbolic interest rate cut in November.
Looking ahead, we expect the PBoC to cut the RRR by another 50bp within three months. We do not expect it to cut the leading interest rates further. In our view, we are not entering a phase of more substantial monetary easing in China, but we also underscore that it probably remains in a phase of managed deleveraging where the policy focus will remain on containing credit growth and managing financial risks. Hence, we are unlikely to see a sharp pick up in credit growth.
We expect a moderate recovery in Chinese growth in H1 15 supported by modest monetary and fiscal easing and some improvement in global growth, but we do not expect a strong recovery. (PMIs are unlikely to improve above 52, in our view.)
We do not expect China to join the global currency war and allow the CNY to depreciate markedly to support growth. Admittedly, there has been depreciation pressure on the CNY recently and USD/CNY has recently been trading close to the ceiling in the daily trading band (see chart below). However, the USD/CNY fixing used to fix the daily trading band has been kept largely unchanged, suggesting the PBoC is not targeting a weaker CNY to support growth. Looking ahead, we expect we expect the CNY to strengthen within the daily trading band supported by a markedly higher trade balance surplus. We think the daily trading band will eventually be widened further but not until late 2015/early 2016 in our view (currently +/- 2%).
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