PBOC cuts benchmark interest rates

By Economics Monitor

Nov 21, 2014 03:27 PM EST

Recently released Chinese data suggest a grim economic outlook for the country. Foreign direct investment has been consistently declining; consumer price index showed some stability this month but remained below 2 percent, flash manufacturing PMI also declined in November and gross domestic product fell to its slowest pace since the global financial crisis, registering 7.3 percent year-on-year expansion in the third quarter.

Also rapidly falling home prices are adding to fears that economic slowdown will further deepen in the days to come. In addition, banks are charging each other with higher borrowing cost which in turn is leading to tightening of credit.

Daniel Briesemann, an analyst at Commerzbank AG in Frankfurt, said, “The decline in China’s home prices gives rise to new fears about a significant cooling of the property sector”.

"Liquidity is tight -- there's panic in the market," said a trader based in Tianjin.

In response the People’s Bank of China said, “The central bank will use a variety of monetary-policy tools to offer liquidity support when needed”.

The PBOC has reportedly pumped 769.5 billion yuan into the banking system during September-October using a newly created lending facility. Even then, bank lending fell to 548.3 billion yuan in October from 857.2 billion yuan in September.

Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong said, “There are serious problems with China’s monetary policy transmission mechanism. The central banks have pumped money into the banking system, but banks don’t have any intention to lend. Monetary policies are ineffective in bolstering activities on the ground.”

Hence, the question that remains is- Will easing of the monetary policy solve the problem of slowing economic growth?

Economists say that sustained weakness in the economy will leave the central bank with fewer options other than reductions in the benchmark rates or reserve requirement ratios.


Today, the PBOC announced that it will lower its one-year benchmark lending rate by 40 basis points to 5.6 percent and slash its one-year benchmark deposit rate by 25 basis points, to be effective from 22 November
.

Commenting on the latest announcement, Vincenzo Longo, strategist at IG said, "(The rate cut is) as expected after disappointing PMI manufacturing data and the recent slump in house prices. On a euphoric day like today, this piece of news is adding fuel to the fire."

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