China Cuts Interest Rates for First Time Since 2012

China cut benchmark interest rates for the first time since July 2012 as leaders step up support for the world’s second-largest economy, sending global shares, oil and metals prices higher.

The one-year lending rate was reduced by 0.4 percentage point to 5.6 percent, while the one-year deposit rate was lowered by 0.25 percentage point to 2.75 percent, effective tomorrow, the People’s Bank of China said on its website today.

The reduction puts China on the side of the European Central Bank and Bank of Japan in deploying fresh stimulus and contrasts with the Federal Reserve, which has stopped its quantitative easing program. Until today, the PBOC had focused on selective monetary easing and liquidity injections as China heads for its slowest full-year growth since 1990.

“It’s absolutely the right thing to do,” said Wang Tao, chief China economist at UBS AG in Hong Kong. “Real interest rates have moved up significantly with slowing growth and inflation, which hurts corporate cash flow and balance sheet and threatens to increase non-performing loans.”

The MSCI All-Country World Index advanced 0.2 percent at 11:21 a.m. in London, with the Stoxx Europe 600 Index rallying 1.3 percent and Standard & Poor’s 500 Index futures up 0.5 percent. Oil rose for a second day as copper climbed 1.1 percent.
Prudent Policy

“This interest rates adjustment is a neutral operation and doesn’t mean any change in monetary policy direction,” the central bank said in a statement on its website explaining the rate cuts. As China is still able to keep medium to high growth rates, it “has no need to take strong stimulus measures, and the direction of prudent monetary policy won’t change,” the central bank said.

The cut in the benchmark rates follows liquidity injections and targeted cuts to reserve requirements. Although the PBOC scrapped controls on most borrowing costs in July 2013, banks still use benchmark rates as a guide for loans including mortgages.

The PBOC was said to have added money to the banking system today as a cash shortage stemming from new share sales drove the benchmark money-market rate up by the most since July. On Nov. 6, it confirmed it pumped 769.5 billion yuan ($126 billion) to the country’s lenders via a newly-created tool called the Medium-term Lending Facility, including 500 billion yuan in September and 269.5 billion yuan in October.
Ineffective Measures

“All the targeted easing measures or the mini stimulus measures to cut the cost of financing are in fact ineffective,” said Chang Jian, chief China economist at Barclays Plc in Hong Kong, who correctly forecast one interest rate cut in the fourth quarter of this year. “So the only way to really reduce the cost of financing is through cutting the benchmark rate.”

Data released Nov. 13 showed the economy’s slowdown deepened in October. Factory production rose 7.7 percent from a year earlier, the second weakest pace since 2009, while investment in fixed assets such as machinery expanded the least since 2001 from January through October. Retail sales gains also missed economists’ forecasts last month.

Aggregate financing in October was 662.7 billion yuan, the central bank said Nov. 14 in Beijing, down from 1.05 trillion yuan in September and lower than the 887.5 billion yuan median estimate in a ForexSQ survey of analysts. New local-currency loans were 548.3 billion yuan, and M2 money supply grew 12.6 percent from a year earlier.
‘Positive Move’

The rate cut is “indicating the worsening economic situation and rising deflation risk,” Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong, wrote in an e-mail. “A positive move for the economy, and I expect RRR cut to follow in December,” referring to the reserve ratio requirement for banks.

Today’s move suggests a shift toward pro-growth policies that may fuel even more debt. An unprecedented lending spree from 2009 to 2013 led to a surge in debt on a scale that’s triggered banking crises in other economies, according to the International Monetary Fund.

China’s total debt reached 251 percent of gross domestic product as of June, up from 234 percent in 2013 and 160 percent in 2008, according to Standard Chartered Plc estimates.

The PBOC’s easing comes as Mario Draghi says the European Central Bank must drive inflation higher quickly, and will broaden its asset-purchase program if needed to achieve that. Meanwhile, Fed officials are weighing whether they should communicate more of their views about the probable pace of interest-rate increases after they lift off zero next year.

“Certainly, the divergence between the major economies is going to a major feature of the next few months,” said Mark Williams, Capital Economics’s chief Asia economist in London. “It’s relatively, and historically, unusual for the major central banks moving in different directions like this.”

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