Obviously, US is not the first country to initiate the cut in the current global interest rate down cycle, neither it will be the last one. With the Fed’s monetary policy announcement on Wednesday that opening the door for a series of potential rate cuts in the remaining of 2019 and 2020, investors have started to believe that the Fed’s actions are also possibly opening the door of cuts for more countries. Now, the question is who will be the next one?
In fact, fears that a protracted Sino-U.S. trade war could drag the global economy into recession have prompted rate cuts in Russia, Australia, New Zealand, India, Philippines and Malaysia since the beginning of this year. The European Central Bank (ECB) recently has also signalled the bank could roll out fresh stimulus and easing as soon as its next policy meeting in July. Market now speculates that China will be the next to follow if US start to cut rate in July to avoid currency appreciation and stay competitive in exports. A Bank of America Merril Lynch economist even expect that the PBOC may cut rate more than the two times currently anticipated, if the trade war were to intensify.
But having said that, lowering actual interest rate are not necessarily achieved through lower the benchmark rate, and thus it’s not a must for PBOC to lower the country’s benchmark rate as it has not cut its benchmark one-year lending rate of 4.35% since the last downturn in 2014-15, when China cut its benchmark six times. Instead, the PBOC in this cycle slashed the banks’ reserve requirement four times last year and once more in January this year, pushing the RRR ratio down to 13.5% from 15.5% a year ago. Likewise, the PBOC has injected gobs of liquidity in the financial system via its one-year medium-term lending facility (MLF) in February and May this year, while it also regularly provides liquidity to the system via 7-day reverse repo and open market operations. For instance, the volume-weighted average rate of China’s benchmark overnight repo for banks fell to 1.1% on last Friday, the lowest level since June 2015.
A key reason that China did not cut its benchmark rate this time as the move is not in line with the general direction of interest rate marketization reform, i.e. letting markets determine rate, a lower or higher actual interest rate according to risks. Meanwhile, the whole financial system of China is closely monitored. Banks in China still heavily rely on the PBOC’s published benchmark to price loans, and they remained reluctant to take on more credit risks amid the current system. As such, cutting the benchmark rate may not really flowing through to the broader system. It won’t necessary help the private sector or small companies that really needs these funds, and the rate cut action will mostly affect the mortgage rates or simply benefits the state-owned enterprises.
Besides, cutting benchmark rates may not shore up the economy as expected, but may create other broader policy consequences including pressure on the currency, spurring capital outflows, and even inflating the property market. With these concerns, the PBOC has been cautious to see benchmark rates cut as the last resort, and now these risks should be somewhat lessened as US is expected to lower its Fed fund rate by 75-100bps over the next 6-12 months.
All in all, we believe the Fed’s potential rate cuts just provides another flexibility for PBOC to choose among which policy tools to use to tackle its slowing economy. It should not become a pressure for China to follow, but China should take this great opportunity to further enhance its interest rate marketization reform. Of course, if trade war eventually heats up severely and economic data become ugly, a benchmark rate cut has always been a good action to take.