China's Latest Rate Cut: How Will It Affect The Nation's Economy?

China’s stock market and economy have been enduring bumpy rides in recent weeks, as a sharp decline in stock prices prompted the People’s Bank of China (PBC) to lower the reserve requirement ratio (RRR) for targeted banks and cut both the lending and deposit benchmark interest rates. Nomura analyst Yang Zhao released a report this week detailing the firm’s most up-to-date take on the situation in China and discussing the impact that the PBC decision will have on the Chinese economy.

Larger than expected cut
While the timing of the PBC easing was not particularly surprising, the magnitude of the changes it made were larger than Nomura anticipated. The PBC cut the RRR for financial companies by 3.0 percent and slashed both benchmark interest rates by 0.25 percent. Following the cuts, the benchmark one-year bank lending rate will be 4.85 percent and the one-year deposit rate will be 2.00 percent.

According to Zhao, the magnitude of the moves by the PBC was unexpected because of the current fragility of the Chinese economy. “The nascent improvement in growth momentum is still fragile given weakening investment growth, and inflation is well below the PBoC’s target,” Zhao explains.

Economic impact
According to the report, the RRR cut will inject about RMB650bn of liquidity into the Chinese banking system. Despite the cut, Nomura is still calling for year-over-year Q2 GPD growth in China to fall to 6.6 percent in Q2 before climbing back to 6.8 percent by Q4. Zhao believes that the move should be viewed mostly as an effort to reduce the possibility of an economic crisis following the greater than 10 percent two-day decline in Chinese equity markets.

Forecast
Nomura is calling for one more RRR cut and one more benchmark interest rate cut in China by the end of the year. The firm expects another 0.5 percent cut to RRR and 0.25 percent cut to interest rates possibly as soon as August.