China Cuts Rates – Credit Demand Remains Weak?
CHINA The People’s Bank of China (PBoC) has been easing financial conditions since January 2022. Despite its latest unexpected cut of the 1-year Medium-Term Lending Facility (1y MLF), demand for credit and economic activity remain weak. We continue to expect GDP (Gross Domestic Product) to rise no more than 3.5% in 2022.?
PBoC surprised the market by cutting its 1y MLF by 10bps, to 2.75%. The adjusted MLF was coupled with a similar reduction to 2.00% in the 7-day reverse repo rate (7d RRP,) an anchor for money market transactions. The last time these policy tools had been lowered was in January. ?
The policy adjustments should lower the Loan Prime Rates later this week by around 10bps for the 1y tenor, and possibly also for the 5y tenor.?
?Liquidity Injections have not Done the Job ?
Since the start of 2022 policy interest rates have only been cut 20bps year-to-date. The PBoC has, however, been lowering the cost of funding via liquidity injections. As a result, M2 money supply growth has been steadily rising to 12.0% y/y in July, from 9.0% by end-2021. ?
Despite flush liquidity conditions, credit demand remains weak. Even accounting for the seasonal monthly drop in credit in July, aggregate financing came in much lower than expected. We estimate bank loan growth eased further to 10.5% y/y in July, limiting the gains in aggregate financing to 11.7%. ?
The persistent woes in the property sector exacerbated the lackluster confidence among consumers and businesses due to the shifting epicenter of COVID infections.?
?Decline in Industrial Production, Retail Sales and Property Prices ?
Domestic activity lost momentum in July, to a surprising degree. In other words, the recovery due to the re-opening of Shanghai has quickly faded. ?
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Industrial production did not only come in below median forecasts, y/y gains also fell from June. Meanwhile, weak consumer sentiment is evident in the slow growth in retail sales. Property prices in third-tier cities contracted further, with 40 out of 70 cities reporting monthly price declines. ?
For the month of July, the main driver of economic growth was exports, which was still benefiting from delayed outbound shipments. However, export orders are cooling, indicating that the support from external trade will fade.?
?Confidence in the Property Sector Needs to be Restored?
Policymakers will need to step up on fiscal support to stabilise domestic demand. The Politburo has now allowed more flexibility to local governments in terms of reaching the annual growth targets. Even so, the weakness in overall growth outlook will require greater policy coordination. ?
In particular, local governments will have to restore confidence in the property sector, by ensuring that the suspended construction activity of pre-sold property developments resume. Otherwise, the persistent liquidity challenges in the sector may transform into a solvency issue.?
Meanwhile, the space for further monetary policy easing may be limited. The PBoC has already signaled its discomfort in the rising inflationary environment.?