China signaled earlier this week that it planned to cut reserve requirements for banks, and the move it delivered Friday was seen tacitly underlining worries about slowing growth in the world’s second-largest economy.

The People’s Bank of China announced that its reserve requirement ratio, or RRR, would be lowered by a half point, to a weighted average of 8.9%, effective July 15. That means banks have to hold less cash in reserve, making more available to lend.

The PBOC, in a note, effectively described the move as nothing special, said Société Générale economists Wei Yao and Michelle Lam. The central bank said its monetary policy stance remained prudent and that the liquidity released by the RRR cut would replace the medium-term lending facility loans due to expire in coming months, offsetting liquidity pressures around tax season, the economists noted.

But even if the cut does end up being “liquidity-neutral,” it still sends a message, the SocGen economists said, in a research note.

An RRR cut “of any kind is no ordinary liquidity injection and should be treated as an
unambiguous easing move, because it provides long-term liquidity and lowers the banks’ funding costs, thus exerting more downward pressures on interbank rates and bond yields than any other instrument,” they wrote.

The shift puts the PBOC on a different footing than the Federal Reserve and European Central Banks, whose next moves are expected to be aimed at beginning to withdraw the extraordinary monetary support delivered during the pandemic. At the same time, China has attempted to squelch a surge in commodity prices.

“It’s difficult to say that today’s [RRR] cut marks a 180 degree shift by the PBOC; on the whole, regulators are still looking to curtail the extent of resource misallocation and leverage within the domestic economy,” said Stephen Gallo, European head of FX strategy at BMO Capital Markets, in a note.

“But it is a signal that the PBOC has no intention of fully mirroring other major central banks as they start to normalize their own policy settings, and it reaffirms China’s position as the global counterweight at this point in the cycle,” he said.

The move came after the State Council, the Chinese government’s central administrative authority, signaled previously that an RRR cut could be in the offing to help banks lend to small firms. The cut would release 1 trillion yuan ($154 billion) of liquidity, helping to lower funding costs for Chinese lenders by CNY13 billion each year, the central bank said.

The cut was at the larger end of what could be expected, said Freya Beamish, chief Asia economist at Pantheon Macroeconomics. And while there was scope for a targeted reduction, the cut will instead apply to almost all banks, which will provide a “significant boost” to interbank liquidity, she said (see chart below).

Pantheon Macroeconomics

The State Council and the PBOC, however, may not be looking at the cut in exactly the same way, Beamish said.

For the PBOC, the focus is likely on managing interbank liquidity ahead of the issue of a large quantity of local government bonds, while State Council is “justifiably fretting about an economic soft patch.”

Even within the PBOC, views may differ, she said, but the bottom line is that the cut shows policy makers are looking to play it safe as the spread of variants of the coronavirus that causes COVID-19 continues.

“We think that the soft patch is temporary, however, and induced in large part by the variants scare. We reckon that the vaccines will win out against the variants by the end of the year, and the PBOC will then get back to the business of normalization,” Beamish wrote. “Either way, the RRR cut sharply reduces the likelihood of a disorderly rise in yields.”

The SocGen economists said that RRR cuts have never been used when the economy “is doing well.” And they expect next week’s second-quarter gross domestic product data to disappoint, forecasting a 7.8% year-over-year expansion versus the consensus of 8%, while warning that “downside risks seem significant” following the RRR cut.

“Some may argue that any downside surprise in the July data could be attributed to the Guangdong outbreak (now contained) and would therefore be temporary,” they wrote. “However, policy makers do have a reason to be concerned given the global
spread of the delta variant, which means local outbreaks are likely to keep popping up.”

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