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The People’s Bank of China is likely to respond to the double blow to the economy from the most serious Covid outbreak since April 2020 and rising raw material costs with a cut to banks’ reserve requirements and increased liquidity injections in the second quarter, but Federal Reserve tightening makes benchmark rate cuts less possible, policy advisors and experts told MNI.

A surge in Covid-19 that shut much of Shanghai, a financial centre and the world’s largest port, together with several major coastal cities in late March has significantly hurt the economy and hit consumption and production, said Lian Ping, chief economist at Zhixin Investment Research Institute.

China’s official manufacturing PMI fell into contraction in March for the first time in five months, according to data released on Thursday, with Lian attributing the drop not only to the lockdown, but to rising inflation fueled both by the conflict in Ukraine and a weaker yuan, and to volatility in financial markets ahead of Fed rate hikes.

First quarter economic growth should reach 5%, slightly higher than last year, but lockdowns in economically key cities in east and southeast China could cut exports by CNY300 billion, about 1.5% of China’s total in 2021, Lian said. This could slow export growth to 8% year-on-year in March from 13.3% in January and February, down from nearly 20% in March 2021.

Industrial production growth should decline to 5.5% in March from 7.5% in the first two months in 2022 and 14.1% in the same month, as the rise in March retail sales slides to 2% from 6.7% in January and February, he said.


Lockdown rules are stricter than during the first outbreaks in 2020, a Shanghai-based advisor told MNI, adding that more expansionary spending polices to bail out small businesses and the services sector are needed. Shutting down the world’s biggest seaport will hurt shipping and supply chains, he said, asking for anonymity.

Fiscal stimulus aimed at securing China’s 5.5% growth target should shift into a higher gear in the second quarter, when pandemic measures should ease, bringing higher credit demand for real estate, infrastructure and other domestic spending, Lian said, predicting outstanding total social finance would grow by 10.3%-10.5% in Q2 to as much as CNY8.5 trillion.

The PBOC should support the expansion in credit by cutting reserve requirements, while boosting its open market operations and introducing targeted measures and window guidance to lower borrowing costs for lenders. It should also enhance support for small and medium-sized companies and big infrastructure projects, Lian said.

But cutting benchmark rates would eat into banks’ net lending margins, a former PBOC official said. A tightening Fed is also crimping policy room, making benchmark cuts unlikely for fear of feeding capital outflows and adding to downward pressure on the yuan, the official added.

The yield on 10-year U.S. Treasuries has jumped to around 2.5%, cutting the yield discount to Chinese government bonds to 29 basis points, the lowest since 2011, according to Wind Information.

U.S.-China yield differentials could invert if the Fed hikes 50bps in May, the official told MNI, though he added that this should not be enough to divert the PBOC from overall easing as the yuan should draw support from the trade surplus and domestic demand for the currency in the second half of the year.


The yuan is likely to trade in a band of 6.2 to 6.6 to the dollar in the second quarter, said Lian, adding that concerns economic sanctions applied to Russia could spill into China could also weigh on the currency but noting that authorities had tools to curb volatility if necessary.

The yuan is entering into a period of two-way volatility, said the Shanghai-based advisor. A key level will be 6.40, he said, adding that a breach could trigger further depreciation. USDCNY opened on Friday at 6.343.

Chinese exporters are sitting on as much as USD500 billion that could come in the market to purchase yuan, the PBOC source noted, but Xu Hongcai, deputy director of the Economic Policy Commission of the China Associate of Policy Science, pointed to the danger of a deterioration in U.S.-China relations as a significant threat to the currency.

MNI London Bureau | +44 203-865-3829 |
MNI London Bureau | +44 203-865-3829 |

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