MNI PBOC WATCH: LPR Reduction Eyed, MLF Downgrade Next
China's LPR held steady Thursday, but a fall could occur next.
China's Loan Prime Rate will likely fall in coming months as lenders’ funding costs decline due to lower deposit interest rates and as regulators crack down on extra interest payments to depositors, while the central bank looks to downgrade the role of its medium-term lending facility.
The Loan Prime Rate, based on the People’s Bank of China’s medium-term lending facility (MLF) rate and quotes submitted by 20 banks, remained at 3.45% for the one-year maturity and 3.95% for over-five-year tenor on Thursday. The LPR last changed in February when the five-year plus maturity fell 25 basis points, while the one-year rate held steady.
The pause was in line with expectations following the PBOC’s decision to keep its one-year MLF rate steady on Monday, while lenders were reluctant to lower quotes thanks to narrow interest margins. (See MNI PBOC WATCH: China LPR To Hold On PBOC's Cautious Stance)
LPR IMPROVEMENTS
PBOC Governor Pan Gongsheng said on Wednesday in Shanghai that the Bank will further improve the LPR system, enhancing the quality of bank-submitted quotations to ensure it more accurately reflects the real interest rate, noting certain quotes have “significantly deviated from the actual rates offered to the most favourable bank clients."
The 20 commercial banks that contribute to the LPR’s formation adjust their quotes on a monthly basis according to their own funding costs, market supply and demand, and risk premiums.
Since April, the central bank has taken measures to ban so-called "manual interest subsidies" which some lenders use to pay additional interest to depositors above official rates in a bid to attract deposits. Meanwhile, many small and medium-sized banks have continued to cut deposit interest rates. Deposit costs are expected to fall, which will benefit banks’ profits and push down their LPR quotes in Q3.
MLF DOWNGRADE
A range of factors, such as the weak yuan and the PBOC’s desire to curb interest rate arbitrage, will make an MLF reduction less likely, alongside the PBOC’s unexpected diminished emphasis on the rate, which Pan revealed Wednesday. (See MNI: China Yuan Seen Breaching 7.3, Strengthening Against Basket)
The Bank will consider granting its 7-day reverse repo rate more power as a key policy rate while “the rates of other-term monetary-policy tools can gradually reduce their policy rate emphasis, thereby streamlining the transmission from short-term to long-term rates,” Pan noted on Wednesday.
Some investors interpreted Pan’s statement as downgrading the MLF from its core position in China’s current policy-rate system, lessening its connection with the LPR. The central bank will in future place more focus on controlling short-end interest rates.
Citing “industrial insiders,” the PBOC’s Financial News service reported after Pan’s speech that the link between the LPR and MLF rates should be further de-emphasised, as the former can decrease depending on whether banks' funding costs lower, with deposit interest rates a significant factor.
Pan said the PBOC will use policy tools flexibly, such as interest rates and the reserve requirement ratio, while “avoiding significant loosening or tightening” as maintaining price stability and promoting moderate price rises remain important considerations.