China puts monetary easing on hold with Fed set to hike

Bloomberg

China’s central bank abstained from cutting a key policy interest rate, avoiding further policy divergence from the US that could add pressure on the yuan.
The People’s Bank of China (PBOC) kept the rate on its one-year medium-term lending facility at 2.85% on Wednesday, in line with most forecasts in a Bloomberg survey of economists. The PBOC also rolled over the $29.7 billion of maturing MLF loans.
The decision came hours before a crucial Fed decision, in which US officials may consider hiking rates by as much as 75 basis points, which would be the biggest move since 1994. Policy divergence with the US has wiped out China’s yield premium over US Treasuries, sparking capital outflows and driving the yuan lower.
The onshore yuan strengthened 0.42% to 6.7144 a dollar after the PBOC’s announcement.
“Lots of loosening within a short window will cause the yuan to be more volatile,” Castor Pang, head of research at Core Pacific-Yamaichi International said by phone. “That will drive away hot money from China and weaken the currency further, which is not what Beijing wants to see at the moment.”
China has refrained from aggressive monetary easing measures in recent months as interbank liquidity was ample amid sluggish corporate and consumer demand for credit. Policy makers have instead opted for more targeted lending tools and faster fiscal spending to bolster an economy grappling with a housing market slump and Covid lockdowns.
The PBOC’s decision was followed by government data showing industrial production unexpectedly increased in May, while consumer spending continued to fall as Covid restrictions weighed on confidence.
While Chinese stocks rallied to be best performers in Asia, with the benchmark CSI 300 Index up as much as 1.8%, the country’s bonds further weakened amid improved risk sentiment. Futures contracts on China’s 10-year government bonds fell as much as 0.1% to 100.21, the lowest since May 20.
The focus now shifts to a possible reduction in the loan prime rate. Banks reduced the de facto benchmark rate for long-term loans including mortgages last month after the PBOC lowered the floor for mortgage rates. Even so, borrowing demand remained subdued in May.
Banny Lam, head of research at CEB International Investment Corp., expects banks to reduce the one-year rate by 10 basis points on Monday.
“It is more effective to use LPR cuts as lowering financing costs through a more direct channel can boost economic activities,” he said.
The rollover of MLF loans is still necessary to help banks buy more government bonds, as a record 623 billion yuan worth of local notes will be issued this week to finance infrastructure spending, Bloomberg-compiled data shows.