For a little while last night it was the good old days for the Aussie dollar as it flew on the news that China is cutting reserve ratio requirements for banks by 50 basis points. Goldman explains:
PBOC cut RRR on accumulating signs of weakness in the economy; more easing measures likely to follow in the coming months
PBOC just released an announcement that it will lower RRR (reserve requirement ratio) for all financial institutions by 50 bps, effective February 5th (Thursday), which is in line with our expectation. In addition to the broad cut, an additional 50bp targeted RRR cut has been announced for city and rural commercial banks with sufficient exposure to SMEs, and the RRR for Agricultural Development Bank will be lowered by 450 bps. This is the first broad RRR cut since May 2012; the most recent (targeted) cut was in June 2014.
The total implied liquidity injection is about 630bn RMB, by our estimates: the overall 50bp cut implies around 570 bn RMB, and targeted cuts involve roughly 10% of deposits, accounting for roughly another 60bn RMB.
The main rationale for the cut was likely the accumulating signs of weakness in the economy which include:
- official and HSBC manufacturing PMI data both weak at sub-50 level,
- industrial profits data fell from -4% to -8% in December,
- falling CPI and PPI inflation which indicate deflationary risks (it is not clear if the government has seen the official reading of the January CPI already, but we expect a drop to 1% yoy, the lowest reading since the GFC),
- significant FX outflows which have contributed to tighter domestic liquidity conditions, and
- NPL and default concerns.
Many of these were contributed by tight financial conditions as a result of elevated real interest rates and rapid appreciation of the REER. The softer equity market performance in recent days likely made this decision easier too, as the November-December run-up was probably viewed as excessive by policymakers.
The move will release a significant amount of liquidity which will help to ease financial market tightness. Equally important it sends a very strong signal of policy loosening. A full RRR cut is generally viewed as the most blunt tool in the monetary policy tool box. This will provide a boost to confidence which is likely positive for short term demand growth, and should also help reduce the risks of a protracted period of undesirably low inflation. We expect the 7-day repo rate to ease back down, perhaps to the 3.6%-3.8% range based on behavior following previous RRR cuts. Both the repo rate fix and CNY fix will be important clues to potential further moves and policymakers’ intentions.
We expect further moves in the coming months, as Chinese policymakers often ease along multiple dimensions simultaneously:
- More RRR cuts are likely. With policymakers having demonstrated a willingness to use broad RRR cuts, we expect to see more, though the next may come with a significant lag (likely Q2). If the government wants to offset the effects of FX outflows on domestic liquidity, another 50-75bp per quarter will be needed (by our rough estimate).
- With inflation falling there is also a case to lower benchmark interest rates to bring down high real interest rates. The last cut in November was asymmetric (a bigger cut in lending rates than deposit rates), although we don’t think that would necessarily be the case again. The timing of any benchmark rate cut will be data-dependent, but a cut before the end of the quarter is quite possible.
- The government may allow the CNY fix to depreciate against the USD to ease pressures on exports growth, though we have only a very modest move (to 6.20 on a six-month horizon) in our baseline. A widening of the CNY band to ease the currency (under current circumstances, the spot would probably trade quickly towards the weak side of the band) is a real possibility but is not our baseline at this point.
- Finally, other administrative measures supporting the property sector and infrastructure investments are also often used to as a part of the broad package.
The Aussie rally flamed out, however, and for good reason. This is not great news. As I’ve argued many times, easing is being paced to maintain the glide slope to slower growth. That may mean 3-6 months cyclical pops along the way but nothing more. An RRR cut suggests the economy is decelerating fast (as we’ve seen in recent data) and there’s precious little that authorities can do about it as the property market unwind continues.
I expect we’ll see more easing, of course, but again, only as a support to slowing growth. Aside from anything else, the easing is really only offsetting the accelerating capital outflows that are tightening credit.
This may (or may not) offer some market support for a bit but beyond that not much.
