The Rising Influence of Rising Affluence

[DewDiligence]

China Cuts Interest Rates Again

[See #msg-76397675 for a description of the previous interest-rate cuts in June. Contrary to the WSJ narrative below, the second rounds of cuts was widely expected by private economists (#msg-76964995, #msg-76971559).]

http://online.wsj.com/article/SB10001424052702303962304577507510579917988.html

›July 5, 2012, 7:31 a.m. ET

China's central bank on Thursday lowered interest rates for the second time in less than a month, a surprising move that signals alarm [the WSJ could’ve conducted more fact-checking here; in fact, several private economists predicted a second interest-rate cut this summer—see #msg-76964995 and #msg-76971559] by authorities in Beijing at the state of the world's second-largest economy.

The People's Bank of China said in a statement it will cut the one-year yuan lending rate by 0.31 percentage point and the one-year deposit rate by 0.25 percentage point. In addition, lending rates will be allowed to fall to 70% of the benchmark rate, down from 80% currently.

China's central bank has flooded the local money market with cash in recent days. Since last week, the PBOC has ramped up its use of reverse-repurchase operations, an increasingly important tool for pumping short-term liquidity into the banking system. It did something similar in May, shortly before it cut banks' reserve requirements, freeing up huge amounts of cash that banks could lend out to boost the slowing economy.

The stepped-up use of reverse repos coincided with further signs of economic weakness in China and growing calls for the PBOC to cut reserve-requirement ratios for the fourth time since November.

The central bank injected 143 billion yuan ($22.5 billion) into the market Tuesday, its largest such offering in nearly six months. This follows 125 billion yuan of injections, via two reverse-repo offerings, last week. The moves have pushed the weighted average rate of interbank seven-day repo, a benchmark gauge of short-term funding costs, down to 3.87% late Wednesday from as high as 4.00% last week.

The latest cash injections came after data this week showed China's manufacturing slowed last month to its slowest since November. The economy grew 8.1% in the first quarter from a year earlier, the weakest in three years.

Reverse repos have emerged this year as a popular tool for the PBOC to quench a periodic thirst for liquidity in the interbank market, due either to slow bank lending or seasonal liquidity crunches. In a reverse-repo transaction, the central bank pumps short-term cash into the market by buying government bonds from a primary dealer, who agrees to buy them back within a short period. Chinese terminology differs from that used in the U.S., where a reverse repo is a Federal Reserve operation to drain liquidity from the system and a repo is a Fed operation to pump it in.

Since beginning open-market operations in 1996, the PBOC has mostly sought to drain liquidity—by selling central-bank bills and repos—in times of high inflation and tight monetary policy. But this year, with growth slumping and capital inflows ebbing as expectations for further yuan appreciation diminish, the bank has turned to reverse repos.

It offered reverse repos to all 49 primary dealers seven times in the first half, pumping in 661 billion yuan and exceeding all its previous such injections combined.

Using market operations like reverse repos is more flexible than the blunt instrument of interest-rate cuts, although—unlike reserve-requirement cuts—reverse repos boost liquidity for only short periods. China's policy makers are reluctant to cut the reserve requirements or interest rates too frequently, as such moves could lead to renewed inflationary pressures in the country.‹