On September 17, 2025, the Federal Reserve's Federal Open Market Committee announced a 25 basis point reduction in the target range for the federal funds rate to 4.00%–4.25%. This marks the restart of the Fed’s rate-cutting cycle after a nine-month hiatus and represents the fourth rate cut since the Fed began easing in September 2024. This move by the Fed opened up room for the People's Bank of China (PBoC) to consider lowering rates, especially given that China’s total social financing had reached RMB 433.66 trillion, and the demand for rate cuts among economic entities and individuals was growing stronger. Some economic analysts predicted that the PBoC would follow suit with a rate cut by the end of September. However, as of September 22, the PBoC's loan market quoted rate (LPR) remained stable, with the 1-year and 5-year LPRs at 3.00% and 3.50%, respectively. This marked the fourth consecutive month without any adjustments since May of this year. Meanwhile, its 7-day reverse repurchase rate, announced on the same day, remained unchanged at 1.4%, signaling no reduction in key market rates.
Relevant analysts pointed out that the 7-day reverse repurchase rate is the core rate in the Chinese central bank’s policy rate corridor and the most important interest rate. It not only determines the rates in the money market, bond market, and loan markets but also influences the level of the LPR. Before any cut in the 7-day reverse repo rate, it was unlikely that the LPR would be adjusted downward.
Both the 7-day reverse repo announcement and the LPR announcement point to one conclusion, i.e., despite the Fed's rate cut, the PBoC is reluctant to follow at this stage and has opted for a "wait-and-see" approach. According to analysts, this decision is undoubtedly a result of the internal and external economic conditions facing China.
One of the key factors limiting the PBoC's ability to cut rates further is the ongoing decline in commercial banks’ profitability. Since 2022, the banking system has seen its net interest margins (NIM) continually narrow due to multiple rounds of rate cuts and market competition over deposit rates. In Q1 2025, the nationwide banking NIM dropped to 0.947%, a historic low, while the non-performing loan ratio exceeded 1% in the same period. In other words, the profit margin for banks has been squeezed to the point where it barely covers the cost of risk. Data shows that the ability of banks' NIM to cover non-performing loans dropped from 120.2% in 2021 to 94.7% in Q1 2025. Any further rate cuts by the PBoC would likely exacerbate the squeeze on commercial banks' interest rate margins. For smaller banks, some regional institutions have seen their NIM fall below 0.8%, falling below their risk tolerance thresholds. This results in a lack of incentive for banks to actively reduce the LPR markups, leading to a bottleneck in the transmission chain of the benchmark rate.
Furthermore, the dual pressures of declining returns on bank assets and increasing competition on the liability side have significantly reduced the risk appetite of the financial system. If the Chinese central bank were to hastily push for monetary easing, it could lead to a misalignment of funds remaining trapped within the financial system rather than flowing effectively into the real economy. This is the background for the PBoC’s frequent mention of “maintaining policy continuity and stability”. Only when banks improve their profitability buffers by adjusting deposit rates or structural deposits can effective policy transmission be restored.
Recent movements in market interest rates and the fiscal rhythm in the first three quarters of the year also created technical constraints for the PBoC’s rate cut. By mid-September, the yield on 1-year AAA-rated negotiable certificates of deposit rose to 1.68%, the 10-year government bond yield increased by 0.17 percentage points to 1.88%, and the 30-year bond yield climbed to 2.20%. This signifies a reversal in long-end rates, signaling a tightening of market liquidity expectations. Institutional investors generally believe that the implementation of "anti-overspending policies" and the slowdown of certain fiscal expenditures pose a risk of tightening medium-to-long-term liquidity. In this environment, even if the PBoC were to cut rates in the short term, its stimulatory effect could be offset by rising long-term rates. Historical experience suggests that when long-end yields rise while short-end rates fall, it often reflects the market's expectation that the marginal effects of policy tools are weakening. Meanwhile, the fiscal policy execution in the first three quarters of 2025 has constrained the scope for monetary easing. According to the country’s Ministry of Finance, government bond issuance increased by 120.8% year-on-year from January to July, but in August, new bond issuance fell by 15.3% year-on-year, showing a clear slowdown in new funds. The early release of fiscal policies has already drained some of the marginal support space for monetary policy.
In its latest quarterly report, the PBoC noted that China’s macro leverage ratio exceeded 300% in the first half of 2025, with household debt-to-income ratios reaching 142%. In this high-leverage context, the marginal effectiveness of relying solely on rate cuts to stimulate the economy is diminishing. Policy must be coordinated with fiscal spending and industrial policies. The effects of the required reserve ratio cuts and structural tools implemented after the May Day holiday are still under evaluation, making the PBoC’s stance of “prudent with slight loosening” obvious. Therefore, given the combined constraints of market rates and fiscal pace, the central bank is reluctant to act alone.
Meanwhile, capital outflows and exchange rate pressure constitute an “invisible red line” for any PBoC rate cuts. The inversion of the U.S.-China interest rate spread is another key risk limiting rate cuts. On September 19, the 10-year Chinese government bond yield stood at 1.88%, while U.S. Treasury yields were as high as 4.14%, creating an inversion of 2.26 percentage points, a recent high. This significant inversion reduces the attractiveness of Chinese assets and significantly raises the pressure for capital outflow. According to estimates from several international investment institutions, net capital outflows from China’s capital account reached around USD 100 billion to USD 120 billion in the first half of 2025, continuing to widen year-on-year. With the U.S. dollar index staying high between 103-104, the RMB/USD exchange rate briefly fell below 7.38 in September. If the PBoC cuts rates further under these circumstances, it would further weaken exchange rate support and potentially trigger intensified arbitrage and capital outflows.
Simultaneously, the balance of Chinese bonds held by foreign institutions fell to RMB 3.18 trillion in July 2025, a decrease of 13.4% year-on-year, marking the lowest level in three years. The IMF’s latest assessment pointed out that China needs to maintain a balance between “internal growth stability” and “external exchange rate stability”. Otherwise, any short-term boost from rate cuts could be offset by negative feedback from capital flows. Additionally, the Fed has two more meetings this year, in late October and mid-December, where it is expected to cut rates by 25 basis points each time. This will likely ease the pressure on the PBoC from external factors, such as capital outflows and RMB depreciation.
From a macroeconomic perspective, the impact of U.S. tariffs on global trade and China’s exports will likely become more apparent in the fourth quarter. Combined with the high base effect from the comprehensive stimulus policies after September 2024, the necessity of intensifying efforts to stabilize growth and employment in the fourth quarter will increase. Furthermore, policies to stimulate domestic demand and stabilize the real estate market will put additional pressure on the PBoC to lower the 7-day reverse repo rate and LPR before the end of the year.
The PBoC's decision to delay rate cuts may also be influenced by the upcoming 20th Chinese Communist Party Congress in October 2025, where the “15th Five-Year Plan” will be discussed. Such meetings are typically viewed as signals for medium-to-long-term policy direction. If the PBoC were to cut rates before this meeting, it could prematurely exhaust policy space and reduce the effectiveness of signaling. On the other hand, waiting until after the meeting to release rate cuts in conjunction with new development frameworks could strengthen the “policy combination” effect.
Therefore, it can be expected that, in order to ensure the achievement of the annual economic growth target of around 5% set at the beginning of the year, and to use interest rate cuts to release economic policy signals for important meetings such as the Fourth Plenary Session of the Party Congress, the central bank is likely to cut rates by 25 basis points later in October. Overall, the current situation is one where the central bank is caught in a dilemma, with conflicting forces at play. This scenario aligns with the prediction made earlier by ANBOUND’s founder Kung Chan, who had expressed concerns about this situation. The overly "refined and perfect" design of monetary policy might lead to unclear signals, while poor market reception could render the policy ineffective or even backfire. The result is the current situation: on the institutional side, there is limited room for maneuver. On the market side, there is little reaction. In the end, the central bank will likely need to decisively return to a simpler interest rate lever.
Final analysis conclusion:
The PBoC's decision to wait and observe in September does not mean it has abandoned the idea of rate cuts, but rather that it is gathering momentum. As commercial banks improve their interest margins by lowering deposit rates, the Fed continues to ease external pressure, and the Fourth Plenary Session of the Party Congress brings new policy windows, the Chinese central bank is highly likely to cut the 7-day reverse repo rate and the LPR by 25 basis points at the end of October. In other words, China’s rate-cutting cycle has not ended, but has entered a "slow-variable" phase. It does not follow the Fed passively. Rather, this is a cautious and precise release of signals, taking into account the stability of its financial system, pressures from capital flows, and political agendas.
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Zhou Chao is a Research Fellow for Geopolitical Strategy programme at ANBOUND, an independent think tank.
