MNI PBOC WATCH: PBOC Cuts 7-Day Rate As Reconfigures Framework

The People’s Bank of China cut its seven-day-repo rate by 10 basis points to 1.7% on Monday, following a call from the Communist Party’s recently-concluded Third Plenum to ensure economic growth and as it reconfigures its monetary framework to ensure policy transmission to money and credit markets.

The unexpected cut came as authorities had focused on curbing a bond rally fuelled by speculation over further easing, and were likely driven by poor Q2 GDP growth, which dropped to 4.7% y/y and as deflationary pressure continued. Last week, the Third Plenum made a call to “achieve the annual economic and social development goals”, which include annual growth of about 5%.

The PBOC also said that the one-year Loan Prime Rate was cut 10 basis points to 3.35%. The timing and scale of the cuts potentially indicated a shift in the central bank’s formation of the LPR, which has been based on the PBOC’s Medium-term Lending Facility rate and quotes submitted by 20 banks, and which will now be more closely linked to the short-term repo than to the MLF Rate, which has traded above some wholesale funding rates this year.

The five-year plus LPR was lowered to 3.85% from 3.95%, its first reduction since February. The PBOC also cut the Standing Lending Facilities rate by 10bps, narrowing the interest rate corridor in a bid to increase the impact of the key policy rates. Currently the corridor ranges are from the ceiling set by the SLF to the floor of 0.35% for the interest on excess reserves. (See MNI: PBOC Repos First Step To Narrower Rates Corridor-Advisors)

CALL FROM PBOC GOVERNOR

Last month, PBOC Governor Pan Gongsheng said the 7-day repo rate would gradually become the main policy rate, while others would "soften their role”, and that the interest rate corridor needed to be narrowed.

A lower LPR will further drive down corporate loan and residential mortgage rates, reducing financing costs and expanding domestic demand. The rate is now likely to remain stable over the coming months unless economic recovery falters or deflation worsens, given narrow net interest margins for banks and an official desire to avoid weakening the already-pressured yuan.

An advisor last week told the PBOC-run Financial News any significant reduction to policy rates may not solve China’s economic issues, noting cuts could create more supply capacity.

While announcing the rate cut decision, the Bank also stated it would conduct “temporary exceptions from collateral requirements for MLF operations” for institutions with the appetite to sell medium- and long-term bonds, to increase tradable supply and “alleviate supply-demand pressure in the bond market.”

Since treasury bonds represent the MLF’s main source of collateral at present, the move means the PBOC is trying to increase the supply of bonds in the secondary market to guide a rise in long-term treasury yields and maintain an upward-sloping yield curve. The PBOC wants to control the inversion of the China-U.S. interest rate spread and ease depreciation pressure on the yuan.