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Tuesday, September 20, 2022
China's Monetary Policy Adjustment Space from the Perspective of Unchanging LPR
Wei Hongxu

The latest loan prime rate (LPR) quotation of China released on September 20, as expected by the market, remains unchanged. Although commercial banks of the country generally lowered deposit interest rates in September according to the deposit interest rate mechanism, the medium-term lending facility (MLF) policy interest rate remained unchanged that month. Hence, many market institutions expect that it is unlikely that the LPR interest rate will be adjusted in September. Many market participants also expect that as the adjustment of deposit interest rates releases some pressure on banks, it is still feasible to continue to reduce the LPR in the future. Additionally, some market institutions have proposed that with the continued reduction of MLF, the People's Bank of China (PBoC) may release long-term liquidity to replace MLF by reducing the reserve ratio in the future. This would signify that, before the fourth quarter of this year, the central bank still has room to reduce the reserve ratio and interest rates.

That being said, researchers at ANBOUND are of the opinion that even if there is a reduction in the RRR and LPR interest rates in the future, it would not be accurate to consider monetary policy will continue the trend of easing. On the one hand, when internal and external pressures continue to increase, monetary policy is bound to be adjusted. On the other hand, the corresponding adjustment space is insufficient to bring about a systematic easing effect in improving the market expectations. With this being considered, China's market institutions should not be overly optimistic about the role and effect of future monetary policy.

Looking at the changes in interest rates this year, the LPR interest rate has been lowered three times this year, a total of 0.15 percentage points for 1-year LPR, and 0.35 percentage points for LPR over 5 years. The spread between 5-year LPR and 1-year LPR narrowed to 0.65 percentage points. In contrast, the Federal Reserve has raised its benchmark interest rate by 2.25 percentage points this year, with a one-time adjustment of up to 75 basis points. The PBoC, as it appears has a limited adjustment of interest rates. This actually reflects the cautious attitude of the Chinese central bank's policy, which is in line with the "prudent" monetary policy tone that it has always been emphasizing.

At the same time, with the reduction of interest rates, the performance of China's social financing and credit has not been stable since the beginning of this year. The impact of changes in the internal and external environment has become more significant. It is insufficient for the decline in financing costs to compensate for the impact of economic slowdown and volatility. At least, it is not enough to reverse the sluggish market expectations. ANBOUND has previously mentioned that in terms of the current market environment, lowering interest rates, or even lowering LPR loan interest rates, would not play a crucial role in improving the credit environment. On the one hand, in the context of the shrinking economic environment, there are no strong financing needs for enterprises; on the other hand, due to their own risk prevention needs, banks will not lower the credit threshold. Wu Ge, the Chief Economist of Changjiang Securities, pointed out that despite the continuous reduction of loan interest rates, credit growth keeps declining for 13 months, and it is increasingly showing the characteristic of the "liquidity trap". The relative "excess" of market liquidity also causes the PBoC to opt for reducing the amount of MLF. It is more likely for it to change the trend of liquidity supply and demand, so as to avoid continuous market distortion and loss of flexibility.

After the previous reduction of deposit and loan interest rates, bank deposits in China not only did not decline but instead continued to rise. Data show that in August this year, resident and corporate deposits increased by RMB 0.83 trillion and RMB 0.06 trillion respectively, an increase of RMB 1.17 trillion and RMB 2 trillion from the previous month, and an increase of RMB 0.49 trillion and RM 0.39 trillion respectively year-on-year. Among them, the new scale of resident deposits hit a record high for the same period in history, and the new scale of corporate deposits was only lower than the same period in 2016. This shows that in the slump in the capital market, the increasing risks in the real estate market, together with the rise of various uncertain factors, there is a stronger will for the market entities to save, and it has not changed because of the decline in interest rates. Under such a backdrop, a slight cut in interest rates will hardly bring about the effect of stimulating consumption and investment.

The reduction of interest rates, from the perspective of demand, actually means a decline in future investment returns against the background of unstable expectations. This trend is difficult to reverse through monetary policy alone, but also requires the implementation of other policy tools to increase counter-cyclical adjustment. Recently, the PBoC has also been emphasizing the moderation of aggregate policies and the enhancement of structural policies. The reason may also be that the effect of monetary policy is declining, and it has to seek new tools to bring incremental space.

Researchers at ANBOUND have previously mentioned that China's monetary policy this year may be leaning towards "low in the beginning, high in the end", and gradually improving as the economy recovers. Now, because of the uncertainties brought about by the worsening of the COVID-19 outbreaks, the recovery of the country's economy is slow, hence such an improvement of the monetary policy has to be delayed. As the momentum of "excessive" easing of market liquidity begins to reverse, the time window for China's monetary policy to remain accommodative is gradually disappearing. In particular, considering the major international economies entering the interest rate hike cycle, the interest rate gap between China and the United States is gradually increasing. This, in turn, has also gradually increased the external pressure on its monetary policy. This will make the monetary policy space continue to narrow, and other aspects such as finance will need to play a further role in future macro policies.

Final analysis conclusion:

China's LPR remained unchanged in September, reflecting the cautious attitude of the PBoC. This also means that there is limited room for further easing of the country's future monetary policy. With the increase of both internal and external pressures, as well as market distortions, the role and effect of monetary policy will be limited. With this in mind, there should not be excessive optimism in this regard.

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