Will Beijing loosen monetary policy further?

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Investors breathed a sigh of relief last weekend as the People’s Bank of China finally validated expectations for easier policy by cutting the required reserve ratio for banks. But with uncertainty still high about the outlook for the country’s economy, how will the authorities in Beijing move in coming months?

Adrian Foster, economist at Rabobank, says the RRR cut reflects a recognition on the part of China’s policymakers that a weaker domestic housing market, and weaker demand growth globally, will curtail China’s economic growth and that both represent disinflationary forces.

“We expect this RRR cut to be followed by two further reductions this year, most likely in the first half of the year. The more concrete monetary policy tool of official interest rates is likely to be held in reserve for now, lest events take a renewed turn for the worse in Europe or the US.

“But, over time, as inflation eases further and the property market remains weak – crimping consumer spending – a 25 basis point rate cut is likely in the second quarter of this year. This will be fine tuning rather than the onset of a string of easings.”

But Tao Wang at UBS says the latest RRR cut was prompted by recent tight liquidity conditions in the interbank market and a significant rise in interbank interest rates. “This should not be viewed as signalling a change in monetary policy stance,” she says.

“Until early last week, it did not look likely that the PBoC would need to cut RRR soon, as interbank rates had been dropping steadily after the Chinese New Year. Liquidity conditions tightened last week because banks had to pay additional reserves on margin deposits and increased deposits, and probably the drop in trade surplus and FX inflows.

“We maintain that the timing and number of future RRR cuts will depend on liquidity conditions, especially the timing and amount of net foreign exchange inflows. If the large FX outflows of the fourth quarter of last year prove shortlived and FX reserves resume their increase, we may not see as many RRR cuts as the market currently expects.”

Diana Choyleva at Lombard Street Research says looser bank liquidity is likely in coming months – which could underpin a stock market rally.

“But without addressing excesses in the banking sector and successfully underpinning consumer spending, just throwing money at the economy will result in another rapid acceleration in inflation,” she warns.

“The PBoC is stuck between a rock and a hard place, with the economy in the midst of a cyclical “hard landing” that is much worse than official real GDP data suggest, and money turning over faster in search of higher returns as house prices fall and real deposit rates remain negative.

“Beijing is unlikely to rush to ease credit quotas too much. But as loan repayments are hit by mushrooming bad loans and the growth of deposit creation slows, the authorities may feel pressured to ease the requirement that banks keep their loan-to-deposit ratio at 75 per cent. Furthermore, they may have to raise the effective deposit rate to stem capital outflows.”

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