The central bank for the second largest economy in the world could follow the footsteps of global monetary policymakers who have cut rates or signaled imminent monetary easing in recent months.
The People’s Bank of China announced on Saturday it would reform its interest-rate mechanism. Economists from Société Générale said the move would pave the way for the Chinese central bank to loosen its policy spigots as China faces continued headwinds from trade tensions and weakening global growth.
“This move in itself is not an interest rate cut, but it does set the stage for that to happen very soon,” said Wei Yao, chief China economist for Société Générale, in a Monday research note.
Analysts at Jefferies described the move as a “stealth” easing policy.
The PBOC’s widely anticipated announcement spurred gains in China’s stock markets on Monday. The CSI 300 jumped 2.2%, contributing to a year-to-date climb of 25.9%, FactSet data show.
The S&P 500 SPX, +1.26% and the Dow Jones Industrial Average DJIA, +1.03% were up strongly and also on track to record a third straight gain, up strongly on Monday.
See: Asian markets climb on China stimulus move, trade-talks optimism
The PBOC said it would replace existing benchmark rates and replace them with the Loan Prime Rate, or LPR, for banks pricing new loans.
This rate is pegged to the one-year cost for banks to borrow from the central bank through PBOC’s medium-term lending facility. The hope is these changes would enable PBOC’s policy rate to more accurately reflect demand for liquidity in the banking system, and also ensure the central bank’s policy shifts would have an impact on financial conditions.
“To improve policy transmission and push for a greater degree of rate liberalization, the PBOC has to first abandon its benchmark lending rates and bring in a new loan-pricing mechanism that can make loan rates more sensitive to banks’ borrowing costs,” she said.
At its introduction in 2013, the LPR was supposed to reflect the actual cost of credit for businesses and serve as a more market-based interest rate. Instead, the LPR has instead closely hewed to the PBOC’s unchanging benchmark lending rate which had remained unchanged since 2015.
Even when PBOC injected liquidity into the financial system, driving down rates that banks charge each other for short-term funds, this didn’t translate into a lower LPR. Banks were reluctant to extend funds and lower borrowing costs for private firms as many were seen as riskier than state counterparts, which carried implicit government guarantees.
The hope is that PBOC’s revamp of the mechanism for setting the LPR will push banks to funnel more credit into businesses.
When the new rate is published on Tuesday, Yao expects it to reflect a cut of between 10 to 25 basis points from the previous benchmark lending rate.
PBOC’s move comes as other central banks including the Federal Reserve have looked to loosen policy to counteract a global growth slowdown. Fitch Ratings said that around a third of central banks across the globe have cut rates in the last six months.