Preparing for a rate cut:Interest rate cut could come soon after March

The PBOC should have cut interest rates by now, but the monetary policyhas been restricted by capital outflows. We expect the PBOC to cut theinterest rate 2-3 times this year depending on the degree of capitaloutflows. Our uncovered interest rate parity model shows that the PBOCcan cut the interest rate by 94bp.

The Medium-term Lending Facility (MLF), the PBOC’s medium-term policyrate, is signalling that a rate cut is imminent. The 6-month MLF was cut40bp in Jan-Feb lending and the PBOC will likely cut it by another 25bpbased on the latest gauge of demand.

The government is sending a consistent message that capital outflows arestabilising. Just last weekend at the China Development Forum, VicePremier Zhang and PBOC Governor Zhou reiterated that capital outflowsare moderating. The PBOC has been marking-up the CNY fixing tostrengthen the CNY, which has been up 1.5% since February.q

The PBOC has made a clear change in monetary policy with strong Januaryand February credit, and a change back to using RRR cut instead of OMO.At the NPC, PBOC Governor Zhou signalled a change to a more“aggressive” prudent monetary policy.q。

A delay in a Fed rate hike provides a window of opportunity for the PBOCto cut the interest rate. The ECB has also expanded its QE program. At theearliest, the next Fed rate hike could be in April, but the market is nowexpecting that the next rate hike could slip into July or September.

The government is encouraging leverage buying in the stock market. ChinaSecurities Finance Corp restarted relending facilities to Chinese brokerswith effect from 21 March. The 182-day lending rate to brokers has beencut from 4.8% to 3%.

Our view has been that the economy will likely recover in 2Q driven bygovt policy, which should support a market rebound. The best-performingsectors post the NPC have been Property, Materials, Infrastructure, and IT.Our top picks in these sectors are Vanke/CRLand, Angang/BBMG,CCCC/CRCCE, and Baidu/JD.com.