China Macro:The PBoC cuts interest rate,RRR and liberalized deposit rate all at once

After the market close, the PBoC cut interest rates by 25bp, the sixth rate cutsince last November. After the cut, the benchmark 1-yr deposit rate will bereduced to 1.50% and the 1-yr lending rate to 4.35%. The PBoC also cut RRRby 50bp to 17.5%, releasing RMB700bn to the banking system. Last but notleast, the PBoC also removed the deposit rate ceiling, marking theaccomplishment of interest rate liberalization, at least symbolically.

Rate/RRR cuts in response to growth pressure: The cut is a bit surprisinggiven the backdrop of higher CPI inflation, rising home prices and RMBdepreciation pressure. The move suggests that policy makers are seriousabout defending the 7% growth target this year, after the GDP growth ratedropped below 7% in 3Q15. In any case, the policy environment is highlyaccommodative now: credit growth and fiscal spending have beenaccelerating for a while, while new home starts and land sales have alsoturned around recently. So we are comfortable with the view expressed in our2H outlook that China’s economy would rebound modestly in 4Q15 (to 7.2%YoY) from a deceleration in 3Q. By year-end, we expect no interest rate cutand one more RRR cut.

Limited pressure on RMB: The rate cut should put some pressure on theRMB, but the impact should be limited, and we maintain our year-endUSD/CNY forecast of 6.40. First, the PBoC would currently prefer stability.Second, monetary policy globally moves toward an easing bias: doubts aregrowing for a 2015 Fed hike, and the ECB has just signalled more QE tocome. Third, capital outflows remain an issue, and sizable depreciation wouldonly intensify the pressure.

Goodbye to interest rate regulation: Last November, when the PBoCstarted this round of the rate-cutting cycle, we commented that “at some pointnext year, China will fully liberalize benchmark deposit rates” (link). But givenall the turbulence this year, we still find it surprising to see China’s version of“Regulation Q” was finally removed today. It is our long-held view thatfinancial reform will lead other reforms, and we discussed future directions infinancial reform in Where tsunamis are formed this April. Today’s movesuggests that financial reform continues to move forward despite the recentstock rout. That said, a lot remains to be done on China’s monetary policyframework (for more details, see our primers on China’s liquidity system, 1and 2). For example, it is not clear to us what China’s new benchmark rate is,if all deposit rates are really liberalized.