China: 1yr LPR Cut Only and RRR Next Given Yuan Concerns

Figure 1: RRR for Big Banks (%) 

Source: Datastream/Continuum Economics 

RRR Cut Next Step 

Double disappointment on the LPR with a 10bps rather than 15bps cut on the 1 year LPR and no change for the 5yr rate. The latter has the market puzzled, given last week’s 15bps reduction in the PBOC medium-term facility rate to 2.50%. One reason could be that the PBOC is more focused on increasing lending from banks at the moment, but it is still a puzzle on the 5yr LPR. An alternative line of speculation is that the PBOC knows that a fiscal policy boost is coming and they stopped the banks from cutting the 5yr rate. We see scope for an additional 20bps cut in the MTF rate in Q4, given that PBOC policy communications suggest a measured approach still e.g. quarterly monetary policy report last Friday. This MTF cut in Q4 will likely be matched by a 20bps cut in the LPR rates. 

One of the key reasons for only modest easing in key rates is that China is also trying to slow the pace of Yuan depreciation to avoid domestic capital outflows like 2015. For now the PBOC is using FX intervention to support the Yuan, but this is only tactical given the wide U.S./China interest rate differentials – notwithstanding capital controls. We see USDCNY at 7.45 by end 2023.

Focus will likely switch to more RRR cuts, where 25bps is widely expected in September – PBOC has not tended to cut the RRR and MTF rate in the same month. We also look for 25bps from 10.75% to 10.50% and then a further 25bps in Q4. However, it also worth noting that though the PBOC has moved at a small pace on RRR cuts in the last two years, it can be aggressive. When the big 4 bank crisis came to a head in 1997, the PBOC aggressively cut the RRR from 13% to 6% (Figure 1). We do not see this being repeated, as the big banks are in better financial health than the weaker city commercial and rural banks based on the PBOC stress tests (here) and international rating agencies reviews. 

What will likely occur in China into 2024 is a regional/rural banking crisis, which will have echoes of the U.S. regional banking crisis earlier in 2023. The PBOC stress tests make clear that it rates the 19 domestic systemically important banks well but some are red institutions that are rated lowly.These are mainly rural banks and cooperatives (217) and village banks (118), but also include some city commercial banks.These red institutions are 1.55% of total banking assets and so in aggregate are currently not systemic, but timely restructuring/takeovers are required to reassure the financial system.  The RRR for small banks is currently 8.75% and could be cut more than the RRR for large banks. The RRR for rural banks is 5% for example.