China has reduced its short and long-term interest rates to stimulate economic growth just days after a major Communist Party leadership meeting. Specifically, the People's Bank of China (PBOC) cut its seven-day reverse repo rate from 1.8% to 1.7%, alongside adjustments to its open market operations.

According to Reuters, this is the first reduction in this rate since August last year. The central bank also lowered benchmark lending rates, namely the one-year loan prime rate (LPR) decreased from 3.45% to 3.35%, and the five-year LPR fell from 3.95% to 3.85%. Additionally, rates on the PBOC's standing lending facility (SLF), which provides temporary loans to commercial banks, were also reduced by the same margin.

What has led to this? The rate cuts followed weaker-than-expected economic data for the second quarter and a recent plenum meeting of China's top leaders. The country is dealing with deflation risks, a persistent property market downturn, high debt levels, and subdued consumer and business confidence. Furthermore, trade tensions and global concerns over China's export strength are adding pressure.

China economists noted that the rate cuts were an unforeseen move, likely driven by the significant economic slowdown in the second quarter and the leadership’s goal to meet this year's growth targets. BNP Paribas representatives attributed some of the PBOC’s leeway to the anticipation of Federal Reserve rate cuts, which could alleviate pressure on the yuan due to the existing yield gap with the dollar. According to the official Xinhua news agency, sources close to the PBOC indicated that the rate cuts reflect the central bank’s commitment to supporting economic recovery and aligning with the plenum's growth objectives.

The PBOC also announced a reduction in collateral requirements for medium-term lending facility loans starting in July 2024. This change is expected to increase the liquidity of long-term bonds and contribute to stabilising longer-term yields. Officials from Pinpoint Asset Management suggested that the PBOC’s action, without waiting for the Federal Reserve’s move, highlights the recognition of ongoing downward pressure on China's economy.

Moreover, they anticipate further rate reductions in China following the Federal Reserve's potential rate-cutting cycle. In other developments, the Jiangxi Bank of China has gone under as the banking sector is facing a full-scape crisis with financial institutions being absorbed into larger enterprises.It’s worth noting that, in just one week, 40 banks went under and have been absorbed into larger financial institutions in China. In addition, China’s smaller banks and financial institutions are currently struggling with bad loans and exposure to the ongoing poverty crisis.

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