MNI PBOC WATCH: China LPR To Hold On PBOC's Cautious Stance

The weak yuan, lender’s narrowed interest margin and the continued fall of long-term CGB yields will drive a steady reference lending rate in June and make the People’s Bank of China more cautious over any potential policy rate cut.

The Loan Prime Rate, based on the PBOC’s medium-term lending facility (MLF) rate and quotes submitted by 20 banks, will likely hold at 3.45% for the one-year maturity and 3.95% for the over-five-year tenor on Thursday. The PBOC kept the one-year MLF stable at 2.5% on June 15 for the 10th consecutive month and drained a net CNY55 billion.

The rate last changed in February when the five-year plus maturity was reduced 25 basis points, while the one-year tenor held steady.

PBOC STANCE

The PBOC’s Financial News service last week published a series of reports citing experts and anonymous sources to sooth investor sentiment over weak credit data and warn against risks building in the hot bond market.

While potential exists for policy easing this year, the reports noted further interest-rate cuts faced internal and external constraints, including the narrow net interest margin and the yuan’s depreciation.

“Currently, the China-U.S. interest rate differential has inverted by 220bp, making it quite challenging to maintain the yuan-dollar pair at around 7.2,” the reports stated. “If the net interest margin continues to narrow, it will impact banks' ability to sustainably serve the real economy.” (See MNI: China Yuan Seen Breaching 7.3, Strengthening Against Basket)

Liquidity has remained adequate thanks to the slow issuance of government debt, weak credit demand and generous PBOC injections. A lower policy rate could guide real loan rates down and fuel arbitrage created by the difference between low loan and high deposit interest rates, a situation the central bank wants to correct. (See MNI: Chances Rise PBOC Cuts RRR As Gov Debt Issuance Increases)

At present, the rate of one-year AAA-rated negotiable certificates of deposit have dropped to 2.03%, much lower than the 2.5% benchmark one-year MLF rate, which has weakened the role of the policy rate and the central bank for market guidance.

YIELD DECLINES

The continuous fall of long-dated CGB yields has also presented the central bank with a more significant headache. (See MNI: PBOC Eyes CGB Selling To Curb Bull Bond Market)

The Financial News noted long-term CGB yields will not remain low as 30-year CGBs approached the 2.5% mark last Friday. “Investors buying at the peak of the bond market face significant risks of investment losses,” the newspaper warned. The bond market has continued to rally this week.

The central bank has expressed concerns about long-term yields since April, warning rapid declines could put financial institutions – particularly small banks – in danger, while an overly flat yield curve will make guiding economic expectations harder, causing those same yields to deviate from economic fundamentals.

Meanwhile, nationwide easing in property controls, including the removal of home loan rates’ lower limit, has increasingly decoupled mortgage rates from the five-year LPR and boosted confidence, making the reduction of the five-year LPR less necessary at present.