Forex Investment and Currency Trading

Beijing has changed course: goodbye tightening, hello stimulus. Today, the People’s Bank of China (PBoC) cut lending rates by 27bps, but kept deposit rates stable. The central bank also cut the reserve requirement for all but the five largest banks by 100ppts to 16.5%. It goes without saying that this came as a big surprise.

The move is likely triggered by rising concerns about China equities and the macro-economy in general. The timing likely has something to do with the Asian equity market sell-off today, on the back of the Lehman collapse and fears of more financial contagion in the US. Equities in Taipei were down 4.1%, India down around 3.7%, Singapore 3.3%, Indonesia 4.7%. Beijing must be wondering about how the Shanghai market will open tomorrow (Tuesday), after its 60%+ fall already this year.

There will be worries also about how the US markets open today, and how that hits Asia tomorrow. Lehman et al. do not have any direct impact upon China’s banks (exposures to them in the Chinese banking system are small), but the fear must be about the medium-term impact through the real economy, and of investors just selling out of panic.

Wait to see how Shanghai opens tomorrow, how it will balance the good and bad news, but this is the strongest positive message the market has seen in ages from Beijing. Real estate may benefit too from this signal, though real demand will take longer to become supportive. That said, the central bank is still worried about inflation. This move will be called premature by some, and could complicate price reforms of energy products if it does trigger renewed inflationary pressures.

However,  market senses that the consensus in Beijing is now that inflation is a less serious threat, especially given the sell-off in commodities we have seen in the last two months.

Why drop the loan rate and leave deposit rates fixed? One train of thought popular among China economists is that consumption is positively correlated with nominal deposit rates – since households have few other assets. So you cut into the bank’s interest margin (negative for bank profits, but not disastrously so) but at the same time you (in theory) do not hit consumption. This may well be what the PBoC is thinking too.