China caught in policy dilemma as Fed rate cut looms
Financial markets expect the Fed to lower rates by a quarter point at its 16-17 September meeting, with two more cuts likely by year-end
Highlights:
- PBOC faces policy dilemma as the Fed prepares to cut rates
- Pressure to ease policy conflicts with stock bubble concerns
- PBOC not expected to immediately follow any Fed rate cut
- Limited scope for further easing with rates at record lows
As the US Federal Reserve gears up for an expected rate cut next week, China's central bank is likely to resist a near-term easing in policy as it grapples with a dilemma: how to shore up a weak economy without further fuelling a hot stock market.
Policymakers are under pressure to fend off a sharp slowdown in growth that could threaten jobs and social stability, while avoiding the mistakes of 2014-2015, when aggressive policy easing and retail investor mania ended in a market crash.
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A Fed rate cut could give the People's Bank of China (PBOC) room to ease policy without risking capital flight or yuan depreciation, but policy insiders and economists say the central bank may wait for clearer economic signals rather than immediately follow the US move.
Financial markets expect the Fed to lower rates by a quarter point at its 16-17 September meeting, with two more cuts likely by year-end. The benchmark rate has held steady at 4.25%-4.50% since December.
"The likelihood of a Fed rate cut will give more room for our monetary policy, but we may not necessarily follow," a policy insider involved in internal discussions said, declining to be named due to the sensitivity of the matter.
"Any policy action will depend on the state of the (Chinese) economy. The stock market is very active right now - if we cut rates, wouldn't that just be like adding fuel to the fire?"
Ting Lu, chief China economist at Nomura, expects the PBOC to avoid cutting rates immediately if the stock rally persists, to avoid fuelling a bubble, but said it may deliver a modest 10-basis-point rate cut over the coming weeks if the markets correct.
So far this year, the PBOC has cut its key policy rate - the seven-day reverse repo rate - by 10 basis points and reduced banks' reserve requirement ratio (RRR) by 50 basis points, with both moves announced in May as part of broader stimulus measures.
"While rolling out high-profile rate cuts could fan the flames and inflate a stock market bubble, doing nothing risks worsening the growth slowdown," Lu said in a research note.
"Faced with this dilemma, Beijing needs to tread carefully over the next couple of months, and the PBOC might be reluctant to follow the Fed in cutting rates in September."
While rolling out high-profile rate cuts could fan the flames and inflate a stock market bubble, doing nothing risks worsening the growth slowdown
Hot stocks vs cooling economy
Analysts remain bullish on Chinese stocks, noting that the rally is led by institutional investors, with retailers just starting to join. Chinese households, wary of spending or investing, sit on a record 160 trillion yuan ($22.45 trillion) in savings.
The world's second-largest economy has been hobbled by a prolonged slowdown, as advances in tech innovation and manufacturing have not fully offset declines in traditional industries, stoking increased employment pressures.
Recent data suggested the tide is unlikely to turn soon: July saw factory output growth at an eight-month low, retail sales slumping, and new yuan loans contracting for the first time in 20 years.
Exports slowed in August as the boost from the US tariff truce faded, fuelling calls for more fiscal stimulus. With key August data due, some analysts expect new spending plans and housing support.
The economy grew 5.2% in the second quarter, aided by policy stimulus and a tariff truce with the US.
This suggests sub-5% growth in the third and fourth quarters could still meet the 2025 target, easing pressure for aggressive stimulus. But policymakers must guard against any sharp slowdown that could threaten jobs.
Prior to the Covid-19 pandemic, China's economy grew at an annual average 6.7% pace during 2015-2019, according to government data.
"Two months of weak data could prompt Beijing to implement new mini-stimulus measures, especially for housing," said Larry Hu, chief China economist at Macquarie. "Fiscal policy, which has been less supportive recently, could also be ramped up."
Modest easing
So far this year, the PBOC has eased policy less than expected, partly due to a tariff truce with the US that boosted exports early on. But the balancing act is becoming even more precarious, with higher stakes for China's economy and markets.
The PBOC has played a key role in supporting the stock market, using targeted tools such as swap schemes and relending programs to provide institutions with liquidity for share purchases.
Officials hope that rising stocks will help repair household balance sheets hurt by the property crisis and boost consumption and the broader economy. However, analysts caution that the economic benefits from higher stock prices remain limited.
The policy rate now stands at a record low of 1.4%, down 115 basis points since the start of the US-China trade war back in 2018. The weighted average RRR has been reduced from nearly 15% to 6.2%, also a record low.
"Unlike the US, China has been continuously loosening monetary policy, so the room for further cuts is very limited," said a second policy insider.
