China to reduce lending rates as the economic recovery drags

China will likely make its biggest cut to two of the core lending rates this year as policymakers and the banks are under increasing pressure to reverse the slowing economy and boost the flagging demand.

At its monthly meeting, the People’s Bank of China will announce a reduction in both the one-year and 5-year prime loan rates that affect borrowing costs for households and businesses. This comes after a unexpected cut was made to its closely-related medium-term funding rate last week.

Since lifting pandemic measures at the beginning of the year, Beijing policymakers have faced a number of challenges, including a slowdown in the property sector, weaker imports and record youth unemployment.

In a Sunday statement, the PBoC urged that banks increase lending to businesses to boost growth and stimulate consumer spending. The statement was issued in conjunction with China financial and securities regulators who met on Friday to talk about the “tortuous recovery” of China’s economy.

Bloomberg polled a majority of economists who expect that the LPR for one year will be reduced by 15 basis points. This is the biggest cut since January 2022. The biggest cut in a single year would be a similar reduction to the mortgage-lending rate of five years. LPR rates currently stand at 3.55 per cent and 4.2 percent, respectively.

All economists surveyed predicted a decrease in the LPR. This usually follows a reduction of the medium-term loan facility. After last week’s reduction, the MLF rate which controls liquidity in the banking sector is now at 2,5%, its lowest level since it was introduced in 2014.

Beijing has not released major stimulus despite months with disappointing economic data. Consumer prices fell to deflationary terrain in August and the growth in the second quarter was only 0.8 percent compared to the previous three-month period.

Observers are increasingly concerned about the missed bond payments this month from Country Garden, a real estate developer, and savings products that were linked to investment conglomerate Zhongzhi.

Goldman Sachs analysts wrote that “we believe the risk of systemic concern emerging in China is low. However, spread[s] are likely to remain volatile until macro volatility subsides.” They added that “this may require a concerted effort by China policymakers”.

The Chinese securities regulator released a number of reforms on Friday evening to encourage investment in the capital markets. These include encouraging share buybacks for stabilizing prices and reducing transaction fees for brokers.

LPR is determined in part by China’s largest banks. They are due to release their financial reports for the 2nd quarter later this month. The five-year LPR was reduced in June 10bp. It is closely monitored because it has a relationship with mortgage borrowing costs.

Nomura analysts projected that the LPR for the next year would drop to 2.35 percent by the end the year. The MLF, meanwhile, would fall by 15bp and be 2.35 percent.

They wrote: “However the real problem for the current downturn in growth is low credit demand rather than an inadequate supply of loanable funding.” Beijing may be forced to take additional measures at some point to stop the downward spiral.

Evergrande, China’s largest property developer, defaulted in 2021, causing a severe liquidity crisis. Evergrande , as part of an extensive restructuring, filed for bankruptcy in the US last week.