Flexible H2 money policy foreseen

China's monetary policy is likely to stay accommodative in the second half of the year as the latest economic and financial indicators point to the need for further policy support while growing expectations of U.S. interest rate cuts create more room for easing, market analysts said on Monday.

They said there is quite a strong possibility of cuts to both loan interest rates and the reserve requirement ratio — the amount of deposits that banks must keep as reserve — in the rest of the year.

On Monday, China unveiled its first-half economic growth figure of 5 percent year-on-year, in line with the country's GDP growth target for the full year. However, the country's second-quarter GDP growth slowed to 4.7 percent, lower than expectations and down from 5.3 percent in the first quarter.

Financial data also pointed to tepid credit demand. The increment in aggregate social financing — the total amount of financing to the real economy — stood at 18.1 trillion yuan ($2.49 trillion) in the first half, down by 3.45 trillion yuan compared with the same period last year, the People's Bank of China, the country's central bank, said on Friday.

"The issue of insufficient domestic demand turned prominent in the second quarter, as residential consumption and private investment performed anemically amid a continuous adjustment of the real estate sector," said Wang Qing, chief macroeconomic analyst at Golden Credit Rating International.

"With that, policymakers are expected to intensify growth stabilization efforts in the second half, and there is room for cuts to both interest rates and the RRR," Wang said.

An improving external policy environment may also gradually expand the scope for cutting the policy benchmarks of interest rates, especially the rate of seven-day reverse repos (currently at 1.8 percent), said Ming Ming, chief economist at CITIC Securities.

The PBOC kept a policy benchmark of interest rates — the one-year medium-term lending facility rate — unchanged at 2.5 percent on Monday. This followed the offshore renminbi plumbing the 7.31 mark against the U.S. dollar earlier this month as delayed U.S. interest rate cuts kept the greenback strong.

The expectation of the U.S. Federal Reserve cutting interest rates within the year has grown stronger after the U.S. consumer price index for June increased slower than expected, Ming said. "The possibility of a reduction in loan prime rates deserves attention against this backdrop."

The loan prime rates are China's market-based lending rate benchmarks.

The one-year LPR has stayed unchanged since August at 3.45 percent and the over-five-year LPR stood at 3.95 percent for five consecutive months as of June.

The PBOC vowed at a meeting late last month that it will unleash the effectiveness of the LPR system and a market-based mechanism of deposit rate adjustments to reduce financing costs for enterprises and households, as part of its efforts to focus more on easing cyclical downward economic pressures.

Lou Feipeng, a researcher at Postal Savings Bank of China, said factors that have kept the PBOC from cutting interest rates this year include commercial banks' low net interest margin, a strong U.S. dollar and the central bank's intention to keep long-term government bond yields from dropping too fast.

"As some of the constraints abate, the possibility of cutting the interest rates and the RRR in the third quarter is rising," Lou said.

Lou further said that if the PBOC implements an interest rate cut, it can reduce the RRR at the same time to provide long-term low-cost funding to commercial banks, which will help ease their pressures of narrowing net interest rate margins — the difference between the interest income they earn and interest they pay.

Meanwhile, the new tool of overnight repos, which withdraws short-term liquidity from the banking system, can be used simultaneously to prevent an excessive supply of liquidity, he said.