PBOC announced a 1pp cut in RRR

While we have been expecting one RRR cut per quarter in H2, the 1pp magnitude surprised us on the upside. The cut will take effect on Oct 15 and apply to a wide range of banks, including large commercial banks, joint stock commercial banks, city commercial banks, non-county rural banks and foreign banks. Out of the total of RMB 1,200bn in liquidity released, RMB 450bn will be used to replace maturing MLF and the remaining RMB 750bn will help offset the seasonal rise in liquidity demand during the second half of the month due to tax payments, according to the PBOC.

Although the RRR cut was hinted by the State Council in late September, the timing of the cut is probably also a response to the bearish market sentiment in the past week followed a week of weak equity market performance. On the economic front, a few recent developments have also argued for greater liquidity support from the PBOC, including 1) the disappointing manufacturing PMI readings for September 2) the recent loss of momentum in corporate bond issuance ; and 3) a fall in our composite money indicator , which seems to suggest weakened household and corporate confidence. Moreover, the more hawkish rhetoric from the US administration on its China policy in the past week has on the margin increased the premium on domestic policy easing.

In its official statement, the PBOC said that the monetary policy direction is unchanged and has remained “prudent and neutral”, and thus the RRR cut should not create additional depreciation pressure on the CNY. In our view, given the growth headwinds in store, we still expect interbank rates to be managed down a bit notwithstanding likely higher CPI inflation. But given the authorities’ focus on broad CNY stability, we see a fairly steady CNY in the near term. We continue to believe the authorities will ease as needed to avoid a sharp slowdown in growth, with infrastructure boost being a particularly key policy lever.