China disappoints investors with ‘underwhelming’ decision on key interest rate

China has surprised investors by deciding not to cut an important interest rate that influences mortgages, in a move that economists say will make it tough to revive confidence in the country’s troubled real estate sector which has dragged down prospects for the world’s second largest economy.

The People’s Bank of China (PBOC) kept its five-year loan prime rate (LPR), which stands at 4.2%, on hold on Monday, while trimming its one-year loan prime rate by 10 basis points from 3.55% to 3.45%.

The cut to the one-year rate was widely expected, but the lack of action on the five-year rate was not. Nearly all of the analysts polled by Reuters had predicted that the five-year rate, which serves as the mortgage reference rate, would be reduced by at least 15 basis points.

The outcome was “underwhelming,” Julian Evans-Pritchard and Zichun Huang of Capital Economics wrote in a Monday research note.

“On its own, the latest round of cuts is too small to have a big impact,” the China economists wrote. “[This] strengthens our view that the PBOC is unlikely to embrace the much larger rates cuts that would be required to revive credit demand.”

The LPR sets the interest that commercial banks charge their best clients and serves as the benchmark for household and corporate lending. The one-year rate affects most new and outstanding loans, while the five-year rate influences the pricing of longer term loans, such as mortgages.

People select shoes in a shopping mall in Beijing on June 15, 2023. (Photo by WANG Zhao / AFP) (Photo by WANG ZHAO/AFP via Getty Images)

Wang Zhao/AFP/Getty Images

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A reduction in the rate would lower the cost of borrowing for those taking out loans or paying down interest.

Stocks in Hong Kong and mainland China, as well as the Chinese currency, weakened on the news. Hong Kong’s Hang Seng

(HSI) traded 1.5% lower, falling deeper into a bear market, while the Shanghai Composite

(SHCOMP) was down 0.5%.

The Chinese yuan has lost nearly 6% against the dollar so far this year, as concerns swirl about the future of the Chinese economy, which reported another month of lackluster economic data last week.

Besides a crisis in the property sector, China is battling deflation, weaker exports and record unemployment among younger people.

‘Far from enough’

Economists had expected cuts to the loan prime rate after China made a surprise slash to another rate, its medium term lending facility (MLF), last week. It lowered that by 15 basis points, to 2.5% on Tuesday.

The loan prime rate is linked to the MLF, so new reductions Monday were “pretty much a given,” according to Capital Economics.

Even if the PBOC had met expectations by slashing rates as much as expected, it would have been “far from being enough to boost growth,” Goldman Sachs analysts said in a research note.

The People’s Bank of China (PBOC) building seen in May in Beijing.

Jiang Qiming/China News Service/VCG/Getty Images

The central bank said Sunday that it held a meeting late last week with state-owned commercial banks, government agencies and other institutions to discuss the policy support needed.

During the meeting, China’s economic recovery was described as coming in waves and part of a “zigzag” process, it said in a joint statement with the financial and securities regulators.

“Major financial institutions should take the initiative to act and increase loans, and large state-owned banks should continue to play a supporting role,” they said.

“We must pay attention to maintaining the pace of stable loan growth, properly guide credit fluctuations, and enhance the stability of financial support for the real economy.”

Growing headaches

Monday’s announcement adds to concerns over the state of China’s economy.

On Monday, UBS downgraded its economic forecast for the country, saying it now expects growth of 4.8% for 2023 and 4.2% for 2024. That compares with previous projections of 5.2% and 5%, respectively.

The downgrade was made “in light of a deeper and longer property downturn and weakening global demand,” China economist Tao Wang said in a research report.

“China’s economic growth has decelerated since April as the property downturn deepened. The government’s policy support has arguably been less than was indicated earlier in the year, and less than we expected.”

TOPSHOT – The Evergrande logo is seen on residential buildings in Nanjing, in China’s eastern Jiangsu province on August 18, 2023. Embattled Chinese property giant Evergrande Group filed for bankruptcy protection in the United States on August 17, 2023, court documents showed, a measure that protects its US assets while it efforts a restructuring deal. (Photo by STRINGER / AFP) / China OUT (Photo by STRINGER/AFP via Getty Images)

AFP/Getty Images

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China has tried to shore up support, with the PBOC cutting both LPR rates in June for the first time since August 2022. That was when the economy was being hit by renewed Covid lockdowns and a deepening property downturn.

But after achieving a solid start at the beginning of the year, the economic picture has darkened. A slowdown was recorded across various parts of the economy in July and pressure has worsened in the vast real estate market.

Last week, official data showed consumer spending, factory production and investment in fixed assets had all slowed further in July from a year ago. Meanwhile, Chinese exports that month suffered their biggest drop in more than three years.

The company logo of Chinese developer Country Garden is pictured at the Shanghai Country Garden Center in Shanghai, China on August 9, 2023.

Aly Song/Reuters

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Chinese markets were also weighed down last week by “rising concerns related to the housing market and its contagion to the financial economy,” Goldman Sachs analysts noted in a Saturday research report.

Investors have been worried about the multibillion-dollar debt load of one of China’s top property developers, Country Garden. Lately, the company has missed some payments and suspended trading of onshore bonds, contributing to fears of a default.

Last week, Evergrande, another troubled Chinese developer, filed for bankruptcy in the United States, adding to jitters about a broader crisis. This means it will be even harder for policymakers to forge a turnaround.

“Reviving demand would take much larger rate cuts, or regulatory measures to effectively restore confidence in the housing market,” Capital Economics said Monday.

“The big picture is that the PBOC’s approach to monetary policy is of limited use in the current environment and won’t be enough, on its own at least, to put a floor beneath growth.”

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