China cuts reserve ratio by 50 basis points

China's central bank on Wednesday decided to lower the reserve requirement ratio (RRR), the minimum level of reserves banks must hold, by 50 basis points from Feb. 5.

This is the first universal RRR cut since May 2012.

The People's Bank of China (PBOC) also increased support to some targeted areas, cutting the RRR by an extra 50 basis points for qualified city and rural commercial banks engaged in proportionate lending to small firms, the farming sector and major water projects.

The Agricultural Development Bank of China, the sole policy lender for agriculture, gets an RRR reduction of 4 percentage points.

Currently, big banks must hold 20 percent of their deposits in reserve, while the ratio for small and medium-sized banks is 16.5 percent.

The move comes days after the purchasing managers' index, a main gauge of manufacturing activity, fell below 50 for the first time since October 2012, a sign of a weakening economy. The world's second largest economy grew at the slowest rate for 24 years in 2014.

The PBOC said that it would "continue a prudent monetary policy, striking a balance between tight and loose, guiding monetary credit and private financing to grow steadily and moderately, promoting a healthy and steady economy."

The central bank cut benchmark interest rates for the first time in more than two years in November 2014.

According to estimates by U.S. investment bank J.P. Morgan and some Chinese institutions, the RRR cut could inject 650 billion yuan (104 billion U.S. dollars) into the real economy.

There had been widespread speculation that the PBOC would not roll out more easing until after Lunar New Year on Feb. 19. J.P. Morgan China Chief Economist Zhu Haibin, who expected the cut before Spring Festival, said in a note that the move came now because of "weak growth in the near term and a deflationary environment".

Zhu said recent regulatory measures, including tightened rules on margins and umbrella trusts, have helped contain the risk of liquidity spillover to the stock market, which climbed by more than 60 percent in 2014.

The recent wave of central bank easing around the world may have also played a role, said Zhu, but "domestic factors are the main reasons behind the RRR cut today".

As expectations of renminbi depreciation are increasing and capital outflow worsening, the RRR cut is the only option to replenish liquidity, and will also help ease financing costs, said Qiu Gaoqing, research fellow at Bank of Communications.

Qiu put the liquidity generated by the RRR cut at about 700 billion yuan.

This is the first time that the central bank has tried an universal RRR cut plus a targeted one.

Wen Bin, chief research fellow at China Minsheng Bank, sees the RRR cut as an innovation and reflection of "striking a proper balance between being tight and loose."

Zhu of J.P. Morgan expects further monetary easing in the coming months. "In the very near term, we expect the PBOC will increase the magnitude of reverse repo operation before Chinese New Year, to meet the seasonal high liquidity demand," Zhu said. Such liquidity is only temporary and will be withdrawn after the celebrations.

J.P. Morgan expects one more rate cut of 25 basis points in the first quarter, likely March, and a second universal RRR cut of 50 basis points in the second quarter, said the research note.

Wen of China Minsheng Bank said the PBOC is unlikely to take more easing measures and expects the central bank to consider cutting interest rates only after assessing the situation in the second quarter.