Interest rates cut to tackle slowing growth

Central bank takes 'bold, innovative' decision to stimulate economy

The central bank cut interest rates for the first time since December 2008 to stabilize growth and prevent the economy from slowing further.

The People's Bank of China announced the lowering of interest rates by 25 basis points, effective on Friday.

The benchmark one-year lending rate will drop to 6.31 percent from 6.56 and the one-year deposit rate will fall to 3.25 percent from 3.5 percent.

"The move appears to be bold and innovative, indicating that the monetary authorities believe inflation is declining but still a concern,'' said Liu Ligang, head of China economics at the Australia and New Zealand Banking Group Ltd.

"Beijing realized if lending costs cannot be effectively cooled, China will face further economic slowdown," Liu said.

Brian Lawson, chief economist at London-based Exclusive Analysis, said the interest rate cut fits naturally within the overall policy approach of providing stimulus in periods of slowdown.

"China is suffering along with everyone else from the recession in Europe, and from modest growth elsewhere," he said.

"We would expect Chinese policy measures to be consistent but gradual — and only to accelerate if the global economy appears to face additional downward pressure from shocks, for example, if Greece leaves the euro," he said.

US and European stocks opened higher on Thursday after China announced the rate cuts.

In the first three months of this year, China witnessed the slowest pace of growth in nearly three years, as GDP increased by 8.1 percent year-on-year.

Since the fourth quarter of 2011, the central bank has cut reserve requirements for banks on three occasions, to inject more liquidity into the market by allowing banks to lend out more. It cut the requirement in November for the first time in three years, cut it again in February and also last month.

A key index indicated a worsening slowdown last month.

The purchasing managers' index, a gauge of manufacturing activity, expanded at the slowest pace in six months in May.

A separate PMI from HSBC reported a contraction for seven straight months, the longest since the financial crisis erupted in 2008.

The State Council warned on May 23 that the economy's downside risks are rising and pledged to prioritize stabilizing economic growth.

Lu Zhengwei, chief economist at the Industrial Bank, said the growth has been close to the lower limit of tolerance and inflation has eased. These two factors allow more space for monetary loosening, he said.

The consumer price index, a main gauge of inflation, moderated to 3.4 percent year-on-year in April in line with market expectations, compared with March's 3.6 percent.

Rising uncertainties in Europe have sparked concerns that China may respond with a stimulus of as much as 2 trillion yuan ($314 billion) to cushion the economy.

The National Development and Reform Commission, however, denied that the authorities intend to introduce another "massive" stimulus.

Rather than announcing another stimulus package and depending too much on monetary loosening, China needs to speed up the implementation of its current fiscal commitments, said Yvonne Zhang, vice-president at Moody's Investors Service (Beijing) Ltd.

Qu Hongbin, HSBC's Hong Kong-based chief economist for China, said steady growth is a priority for Beijing and the authorities have sufficient policy tools to roll out a "powerful" package. "In addition to the monetary easing, we believe China will use fiscal stimulus and open up more sectors for private investment."

He expected growth in the second half to rebound to more than 8.5 percent.

Douglas Borthwick, managing director of the foreign-exchange consultants Faros Trading, said the interest rate cut is likely to be the start of a new easing cycle. If Europe continues to twist on the vine, more cuts will be delivered.

"Rate cuts in China serve to reduce China's exposure to global weakness. Rate cuts in combination with a stimulus program, still to be announced, should shelter Asia somewhat from global weakness," he said.

Duncan Freeman, senior researcher with Brussels International Contemporary Chinese Studies, said the rate cuts indicate that China is prepared to respond strongly to slowing growth in recent months.

Lower interest rates is "heartening news" to companies as it will help stimulate consumer spending and vitalize production, said Dong Yaojun, from the Shanghai Guangyu Automobile Air Conditioning Compressor Co.

Rate cuts are most likely to benefit manufacturing and trade businesses, said Tang Wenming, chief executive officer of License Software Consulting Co Ltd.