China's surprise run of rate cuts this week has been welcomed as evidence of Beijing's willingness to bolster economic growth. For economists, the moves have also shed light on the central bank's evolving monetary policy framework, including the recasting of a key lending facility in a diminished role.
The People's Bank of China started off the round of easing with a cut to its seven-day reverse repo rate on Monday. That was followed by commercial lenders dutifully lowering loan prime rates on the same day. The central bank then caught markets off-guard again with an unexpected medium-term lending operation at a steeply lower interest rate on Thursday. This marked a departure from the past, not only because the timing of the MLF operation was unusual but also because cuts to the longer-term rate tend to precede and therefore guide loan prime rates, not the other way around.
It was also the second MLF operation in July, with the previous one seeing the PBOC hold the rate unchanged for an 11th straight month.
Two such operations in a month is not the norm, HSBC economists said in a note, with a previous episode in November 2020 taking place after the default of a state-owned enterprise spooked markets.
Economists have widely interpreted this week's unusual sequence of events as evidence that the MLF rate's importance is being purposefully diminished as the PBOC pushes to let short-term rates play a more prominent role in guiding markets. Chinese state media have also hinted in recent weeks that the LPR might be delinked from the MLF rate to better reflect borrowing costs in the economy.
"With the cut of the LPR ahead of MLF rates this week, the role of the MLF rate as policy rate has quickly diminished," economists at Nomura said in a note to clients this week.
For economists at Goldman Sachs, the fact that the LPR moved down along with the seven-day reverse repo rate cut indicates a potential re-anchoring of the LPR from the 1-year MLF rate to the short-term reverse repo rate.
The shift comes after China's central bank governor, Pan Gongsheng, indicated in June his intention for the seven-day reverse repo rate to serve as the new policy benchmark as he sought to simplify PBOC's complex web of policy rates. Since then, authorities have introduced additional overnight repo and reverse repo operations that further elevate the short-term rate's role in guiding borrowing costs.
Delaying the timing of the MLF rate cut could be the PBOC's way of nudging markets to view the earlier seven-day reverse repo rate cut as the easing signal, economists at Pantheon Macroeconomics said.
The downplaying of the MLF rate is also happening as banks' demand for one-year policy loans has weakened in recent months due to cheaper interbank borrowing costs amid affluent liquidity. Falling demand has eroded the instrument's ability to steer market rates.
The phasing out won't happen overnight. One-year policy loans will still continue to serve as an important medium-term liquidity injection tool to offset seasonal demand from periodic tax payments and significant government bond issuance, economists at Goldman Sachs noted.
The central bank probably judges that there's still merit in extending MLF loans as a funding source for banks, for now, OCBC economists said in a note.
But once the central bank's treasury bond operations start, that MLF's role as a cash-management tool will likely diminish further, analysts say.
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(END) Dow Jones Newswires
07-26-24 0555ET
