Other countries rebound as Beijing cuts rate allowing banks to lend more money

Fifth interest rate cut since November expected to boost activity

To the obvious delight of global stocks, which rebounded on the news, but too late to rescue Chinese stocks which fell for a second day to close down 7.6 per cent, the People’s Bank of China cut its key lending rate and lowered the amount of cash large banks must keep in reserves.

The global equities sell-off has been driven by anxiety that China’s slowing economic expansion could affect the rest of the world. Beijing’s fifth interest rate cut since November is expected to boost activity by allowing banks to lend more money.

US markets rebounded as did the FTSE, the DAX and the CAC, with nerves clearly soothed by the PBoC’s decision.

In the main, China’s policymakers have sat silently in the wings despite a 22 per cent plunge in the main index in the past four days, having intervened heavily in July.

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Then yesterday they implemented a simultaneous cut to benchmark interest rates and the required reserve ratio (RRR). The move sees both deposit and lending rates lowered by 25 basis points, taking the 12-month benchmarks to 1.75 per cent and 4.6 per cent respectively. It also said it would reduce reserve requirements by 50 basis points to 18 per cent for most big banks.

“Currently, there is still downward pressure on China’s economic growth,” the central bank said in a statement.

The economy is forecast to grow at its slowest pace since 1990 this year. “There is also relatively big volatility in global financial markets, which require more flexible usage of monetary policy tools.”

Ceiling removed

Also, the interest rate ceiling for fixed deposits of more than one year has been removed – one of the final steps in deposit rate liberalisation, said Mark Williams, chief China economist at Capital Economics in London.

“The move may halt the market slide but we suspect the primary motivation is to shore up confidence in the state of the wider economy. It is notable that, in the two days prior to this move, official purchases of equities seem to have halted,” said Williams.

The People’s Bank of China made no reference to the equity markets in its statement announcing the cuts, focusing on inflation instead.

“All told though, if we are right that this move was triggered by concerns about negative sentiment following the equity rout rather than any new as yet unpublished information pointing to a sudden drop-off in economic growth, it should add to the tailwinds supporting economic growth in the second half of the year,” said Williams.

Shanghai Composite

The benchmark Shanghai Composite Index declined 7.6 per cent, while the smaller Shenzhen Composite fell 7.2 per cent. The Shanghai index has now declined 42 per cent from its peak on June 12th.

“China’s decision to devalue the yuan set in motion a chain of events that ultimately resulted in the current sell-off in global risk assets,” said Andrea Cicione at Lombard Street Research. “But if volatility spikes are not uncommon in late-cycle markets, they don’t necessarily signal an imminent downturn.

“Our macro view remains constructive, and recent developments in China – where we have been more bearish than consensus for quite a while – have not been enough to change it so far,” said Cicione.

China is dealing with deflation risks, too much capacity and a debt overhang, while industrial production, investment and retail data have all disappointed in recent weeks.

“Some investors worry that China, whose economy is now comparable to the US in size, could lead to another ‘2008 moment’ for the global economy.

“Such fears look misplaced: China is a large current-account surplus country when commodities are excluded.

“Its slowdown means commodity exporters will be hit hard, but that doesn’t mean that the world economy is headed into a recession,” said Cicione.