Rate cut tackles exorbitant financing, disinflation risk

China's earlier-than-expected interest rate cut will reduce funding costs for enterprises and tackle looming disinflationary risk amid the continued economic slowdown.

The People's Bank of China (PBOC) on Saturday announced it would cut the lending and deposit interest rates by 25 basis points (bps) on March 1, the latest easing measure by the world's second largest economy.

Lian Ping, chief economist of the Bank of Communications (BOCOM), one of China's five leading banks, described the exercise as a way to relieve financing pressure and to fend off deflationary risk.

"Under the current circumstances, this will help reinforce effects from the last cut, lower the loan rate and social financing cost, lighten burdens on enterprises and stabilize growth," Lian said.

China lowered interest rates in November, the first such action in more than two years, and slashed the reserve requirement ratio (RRR) for banks in early February to stimulate economic growth.

China's GDP posted its weakest growth rate since 1990 in 2014. Consumer inflation in January came in at its slowest pace since November 2009, and the producer price index (PPI), which measures wholesale inflation, declined for the 35th straight month.

"The decline in inflation has pushed up real interest rate by 0.6 percent since the last rate cut," said a HSBC research note, "The move is highly warranted by the need to lower borrowing costs for the real economy."

The rate cut will help stabilize growth by anchoring infrastructure investment and property, according to the note.

WHAT'S NEXT?

After a string of measures including the rate cut and other short-term money-pumping operations, the market still anticipates more as the economy has not yet shown any signs of bottoming out.

Economists and analysts with varied institutions have agreed on one forecast that more easing measures could be expected this year.

"In light of slowing growth and falling inflation, we expect the PBOC will continue to step up easing through further rate and reserve ratio cuts as well as other quantitative tools in the coming months," the HSBC research note said.

Monetary easing will also likely be accompanied by more fiscal spending to contain disinflation, according to the note.

Lian predicts that the central bank will likely cut RRR one or two times given rising pressure from foreign exchange (FX) outflow as yuan funds outstanding for FX have shrunk in the last two months.

But there will not be much room for further rate lowering as the one-year deposit rate has approached its lowest level in ten years, Lian said, adding that China would stick to a prudent monetary policy that featured moderate easing.

Sharing Lian's sentiments, Wu Qing, researcher with the Development Research Center of the State Council, a national think tank, added that policy makers had no plans to conduct massive easing like the U.S., Japan and the European Union.

He predicted that there was a probability this year of the authority carrying out aggressive reform measures to stimulate growth in the long run.

A BOCOM report predicts the looming downward pressure will likely be alleviated after March as pro-growth policies take effect.