China: MTF Cut Arrives Early, But More Rescues and Stimulus Needed
Bottom Line: The PBOC surprised in terms of timing and cut the 1yr medium-term facility rate by 15bps to 2.50%, with 10bps cuts in the overnight and 7 day rates as well. The rationale is clearly shown in the weaker than expected July activity data, which suffers from the property sector downturn and hangover of debt, alongside the significant undershoot of inflation. LPR cuts will arrive next week, with a 25bps cut in the RRR soon. We also bring forward the projected 2024 cuts to Q4 and forecast the end 2023 1yr MTF rate at 2.30%. However, with credit issues worsening in the property and financial sector, this is unlikely to lift growth and takeovers/restructuring are required first in the property and financial sector. We have revised our USDCNY end 2023 forecast to 7.45, which reflects widening spreads and increasing risk of China credit tensions leading to new global investor outflows.
Figure 1: 1yr PBOC MTF Rate (%)
Source: Datastream/Continuum Economics
July data shows a weaker than expected profile for the economy. Yr/Yr retail sales at +2.5%, YTD Yr/Yr slowing to 7.3% versus 8.2% in June, plus a stalling of monthly growth in retail sales show that consumer momentum is running out of steam. The breakdown does show positive momentum in catering services (eating out), but Yr/Yr declines in home appliance and building materials that are being hurt by the downturn in the property market (here). Property investment at -8.1% YTD Yr/Yr also reflects this theme. Meanwhile, July industrial production slowed to 3.7% Yr/Yr versus 4.4% in June, which reflects the slowing domestic momentum but also the weakness in exports. Combined with the recent negative CPI inflation figure (here) and disappointing loan data, this all provides plenty of motivation to stimulate the economy.
The PBOC delivered the MTF cut early (most in the market had expected a move in September) with a 15bps cut to the MTF rate. This will likely be followed next week with a 15bps cut in the 1 and 5 year LPR, though some speculation exists of a larger 20bps cut in the 5 year rate to help lower mortgage rates. Additionally, the expected 25bps cut in the RRR rate could be delivered in August as well, given the weakness of economic data and growing stress in sections of the financial system. Further rate cuts are now likely in Q4 and we have brought forward a further cumulative 20bps of cuts in the MTF rate from 2024 and now see the 1 year MTF rate at 2.30% by end 2023. Though weaker banks have not been in the spotlight this week, we feel it is only a matter of time before some weaker banks run into difficulties and this was actually flagged by the PBOC stress tests (here).
Policy sequencing is now getting important, as rescue efforts must match policy stimulus. It is no good undertaking policy stimulus, if distrust is growing in weaker property developers/wealth managers/LGFV’s and rural banks. With only moderate protection for depositors a flight to stronger financial institutions (e.g. systemically important banks) could start to occur and deepen tensions in the weaker parts of the financial system. Thus as we outlined yesterday, China authorities need to work proactively this month to use the Evergrande model for large property developers and forced takeover of weaker wealth managers and banks (here). At least for weaker LGFV, a Yuan 1trn debt swap has been announced (here). If anything we would argue that these rescue measures are more important than stimulative measures at the moment.
Meanwhile, we are revising our end 2023 forecast on USDCNY from 7.30 to 7.45, both as we are now projecting more 2023 rate cuts in China and a widen interest rate spread versus the U.S. In addition, the growing crisis in the property and sections of the financial system will likely see global investors reducing China asset holdings.