Submitted by Mark Hanna
Courtesy of MarketMontage. View original post here.
While some thought the Bank of England may embark on a new round of QE this morning, instead it was the People’s Bank of China which has announced a surprise rate cut. The past few years the PBOC has been fiddling with reserve rate requirements but this appears to be their first rate cut in a few years. These type of interventions from out of the blue is exactly the reason it is very difficult to be a bear in this era… even a 10% S&P drop now brings out the guns blazing from across the globe. Of course to be fair the Chinese economy is slowing, and is far more exposed to Europe (their top export market) than the U.S. is so I’m being a tad facetious.
Yesterday I mentioned the S&P 500 had “room to 1320s” and in a snap of a finger it is there. Now we await the third central banker of the day testifying on Capitol Hill. We’ll see if Bernanke can “cajole” markets over the highs of last week, which would be a change in trend vs the past few months.
Via Reuters:
- China delivered twin surprises on interest rates on Thursday, cutting borrowing costs to combat faltering growth while giving banks additional flexibility to set competitive lending and deposit rates in step along the path of liberalization. The 25 basis points cut brings the official one year borrowing rate to 6.31 percent and the one year deposit rate to 3.25 percent, confounding the consensus call of economists who thought the People’s Bank of China (PBOC) would refrain from cutting policy rates this year despite wanting to support growth.
- “It’s obviously a very strong signal that the government wants to boost the economy, given the current weakness, especially in demand,” Qinwei Wang, economist at Capital Economics in London, told Reuters.
- The European Union is China’s single biggest foreign customer and faltering demand there has led to worries about the knock-on effect to domestic consumption if industrial activity slows dramatically.
- While the cut to borrowing costs should help in the near term to shore up an economy on course for its weakest full year of expansion since 1999, it is the liberalization measure that is likely to have the greatest longer-term repercussions. The PBOC said it was giving banks the freedom from June 8 to set deposit rates as high as 110 percent of the benchmark rate and offer rates on new loans for as little as 80 percent of official policy rates, an additional 10 percentage points from the current 90 percent limit. Commercial banks until now have been barred from charging rates on deposits higher than the benchmark set by the central bank.
- “It’s a significant move,” Wang said. “It’s a first step in rate liberalization and it increases the returns for households. The lower floor for lending rates creates more competition between banks. So banks cannot guarantee their profits as before.”
- But with a deluge of data due over the weekend that includes all of the country’s key barometers of investment and industrial activity, it raised concerns for others that the rate move is pre-empting grim news. “The concern is that with industrial production and CPI data coming out of China at the weekend that it’s indicative of them knowing something about weak data going forward,” said Adrian Schmidt, currency strategist at Lloyd’s Bank in London.
- The last change to the borrowing rate was in July 2011 when the 1-year benchmark lending rate was raised by 25 bps to 6.56 percent.
- The PBOC has cut RRR for the biggest banks by 150 basis points from a record high of 21.5 percent in three moves since November last year, after a two-year tightening campaign to rein in inflation and cool steaming economic growth.
- The move to cut rates outright – wrong-footing most market analysts who had anticipated a further 100 bps of cuts in the RRR in the second half of 2012 but no cut to policy rates – likely signals China’s belief that inflation is tame enough to take more aggressive easing steps.
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