China's unexpected rate cuts aimed to revive faltering economy

On Monday, China's central bank unexpectedly lowered the key short-term interest rate and reference loan rates. This is another step by the authorities to support the world's second-largest economy, which faces a range of challenges.

China unexpectedly reduced some interest rates. The People's Bank of China (PBoC) announced a 0.10% cut in the seven-day repo rate from 1.8% to 1.7% on Monday. This is the first such decision in almost a year. Simultaneously, the central bank reduced the one-year loan prime rate (LPR) from 3.45% to 3.35%, and the five-year LPR from 3.95% to 3.85%. These decisions surprised financial markets, which didn't expect such swift actions from the monetary authorities.

The interest rate cuts follow the publication of weaker-than-expected economic data for the second quarter and a recent plenum of the Communist Party of China, which occurs approximately every five years.

Experts from PKO BP commented on the decision. They highlight that in the Chinese central bank's communication, the cut aims to optimise the open market operation mechanism and increase support for the economy.

"It may also signal a greater focus by the bank on the short-term interest rate and the anticipation of further cuts in the face of disappointing economic results," the bank's experts write.

They also cite the latest economic data—last week, GDP data indicated that in the second quarter of 2024, the Chinese economy grew by 4.7% year over year, compared to expectations of 5.1% year over year and 5.3% year over year in the previous quarter.

China currently faces a range of economic challenges. The country is balancing on the brink of deflation and grappling with an ongoing real estate market crisis. Concerns are also rising due to increasing debt and weak consumer and business sentiment.

According to experts, the Federal Reserve's start of an interest rate cuts cycle also gave the PBoC manoeuvring room to ease policy. This is important due to the pressure on the yuan caused by the marked difference in yields between China and the United States.

The decision to cut interest rates triggered immediate reactions in financial markets. The yuan's exchange rate dropped to its lowest level in almost two weeks at £5.93 per dollar, although it later recovered some losses.

According to experts cited by Reuters, the yields on Chinese government bonds fell, with the 10-year and 30-year bonds dropping by as much as 0.03% before stabilising at 2.24% and 2.45%, respectively.