China set to cut lending rates as economic recovery drags

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China is expected to make the biggest cuts this year to two of its core lending rates, as pressure mounts on policymakers and banks to reverse a trend of slowing momentum and revive flagging demand in the world’s second-biggest economy.

The People’s Bank of China is set to announce reductions to both one-year and five-year loan prime rates, which affect borrowing costs for businesses and households, at a monthly meeting on Monday, after making a surprise cut to its closely related medium-term financing rate last week.

Policymakers in Beijing have struggled to counter a host of challenges since lifting pandemic restrictions at the start of the year, including a property sector slowdown, weaker exports, record youth unemployment and price deflation as consumer confidence wanes.

The majority of economists polled by Bloomberg expect the one-year LPR, which underpins mortgage lending, to be cut by 15 basis points, the largest margin since January 2022. A similar cut to the five-year rate would be the biggest in a year. The LPR rates are currently 3.55 and 4.2 per cent, respectively.

The polled economists were unanimous in anticipating a cut to the LPR, which typically follows a reduction in the medium-term lending facility. The MLF rate, which manages banking sector liquidity, is now 2.5 per cent, the lowest since it was launched in 2014 after last week’s cut.

Beijing has stopped short of unleashing major stimulus despite months of disappointing economic data, with consumer prices slipping into deflationary territory in July and growth of just 0.8 per cent in the second quarter against the previous three months.

But missed bond payments from real estate developer Country Garden and on savings products linked to investment conglomerate Zhongzhi this month have increased alarm among observers.

“We believe the risk of systemic concerns emerging in China remains low, though spread[s] will likely remain volatile until the macro volatility subsides,” Goldman Sachs analysts wrote on Saturday. This, they added, “may require a more concerted easing effort by China policymakers”.

On Friday evening, China’s securities regulator announced a series of reforms designed to boost investment in its capital markets, including encouraging share buybacks to stabilise prices and cutting transaction fees for brokers, while the central bank has stepped up its defence of the renminbi

The LPR is partly determined by the lending rates of China’s biggest banks, which are set to release financial reports for the second quarter this month. The one-year LPR, which was cut in June by 10 basis points, is being closely watched because of its relationship to mortgage borrowing costs.

Analysts at Nomura projected further cuts to the one-year LPR to 2.35 per cent by the end of the year, while the MLF would be reduced by 15 basis points to 2.35 per cent.

“However, the real issue for the current growth downturn is low credit demand, rather than insufficient supply of loanable funds,” they wrote. “At some point in time Beijing might be compelled to take more measures to stem the downward spiral.”

China’s real estate sector, which typically drives more than a quarter of economic activity, has been paralysed by a liquidity crisis over the past two years following the 2021 default of Evergrande, the world’s most indebted property developer. Last week, Evergrande filed for bankruptcy protection in the US as part of a prolonged restructuring process.