PBOC Trims Mid-Term Funding Costs Amid Market Liquidity Nerves

(Bloomberg) --

China's central bank reduced the cost of 1-year funds to banks for the first time since 2016, seeking to calm markets nervous about tightening liquidity amid a slowing economy.

The People's Bank of China lent 400 billion yuan ($57 billion) with its medium-term lending facility and lowered the interest rate on the loans to 3.25% from 3.3%, according to a statement. The injection replaced 403.5 billion yuan of loans that mature Tuesday.

The cut reflects the bank's cautious approach to stimulus and shows the difficulty in setting policy when debt and consumer prices are rising but industrial prices are falling due to weak demand. Concern about that cautious stance prompted traders to sell Chinese bonds last month, and while this reduction doesn't immediately cut rates in the real economy, it could do so if banks pass along the lower borrowing costs.

The central bank is sticking to “neutral, targeted easing,” said Peiqian Liu, China economist at Natwest Markets Plc. in Singapore. The MLF rate cut is “more of a signal to calm markets,” and the PBOC needs to offer more liquidity in the future to effectively lower overall financing cost, she said.

How the cut will work

The MLF cut will take a while to filter through to companies' borrowing costs. Only the biggest banks can use the facility and smaller and rural financial institutions can't access the cheaper loans. The cut will influence the level of the new de-facto benchmark interest rate - the Loan Prime Rate - when the latest price is released on the 20th of this month. However, not all the new loans are pegged to the LPR yet as it was only introduced in August. Considering all that, Tuesday's reduction will likely benefit only some borrowers in a limited way.

The benchmark 10-year sovereign yield climbed to the highest level since May last week and rose in October by the most in six months. China's 10-year government bond yield declined 3 basis points to 3.264% on Tuesday, erasing an earlier gain. Futures on the debt rose as much as 0.41% to the highest level in over a week.

What Bloomberg's Economists Say...

“Today's move reinforces our view that the PBOC is pursuing a gradual and measured easing bias in its monetary policy.”

“Looking ahead, we expect the MLF rate to trend lower in the coming quarters, reflecting authorities' efforts to reduce funding costs for companies.”

David Qu, economist

See here for the full note

There are various contradictory factors limiting the room for large changes in monetary policy. The price of manufactured goods is a falling as demand and the economy slows, which would normally mean the central bank should add stimulus to boost growth.

However, consumer prices are rising and some economists expect them to hit 4% as soon as November as pork prices surge. Faster inflation would generally mean the bank would be unlikely to add stimulus.

Those constraints, together with Governor Yi Gang's comments to “cherish” the conventional monetary policy, have prompted economists from Nomura International Ltd. to China International Capital Corp to dial back their easing bets for the remainder of 2019.

Authorities refrained from adding cash via open-market operations or with a targeted lending facility last week, resulting in a net liquidity drainage of 590 billion yuan -- the most since February.

“As we see from macro data, China needs further targeted easing to support the slowing economy and now with a firmer yuan versus the dollar, they finally have room to cut MLF,” said Stephen Chiu, an Asia FX and rates strategist at Bloomberg Intelligence. The loan prime rate will probably be lowered further and another targeted reserve requirement ratio cut might still be needed in December, he added.

--With assistance from Claire Che and Yinan Zhao.

To contact the reporters on this story: Tian Chen in Hong Kong at tchen259@bloomberg.net;Livia Yap in Shanghai at lyap14@bloomberg.net

To contact the editors responsible for this story: Sofia Horta e Costa at shortaecosta@bloomberg.net, James Mayger, Malcolm Scott

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