PBOC sends mildly dovish signal with a targeted RRR cut

Effective Apr 25, PBOC announced an RRR cut of 1 percent for qualified banks, including large commercial banks, joint stock commercial banks, city commercial banks, non-county rural commercial banks and foreign banks. These banks have RRRs (required reserve ratio) of 17% or 15%, relatively high compared with other banks, and are also the financial institutions who borrow medium-term lending facility (MLF).

This is clearly a dovish move. The central bank has been avoiding using RRR and benchmark rate changes as both are widely viewed as tools with strong signaling effects. A RRR cut does not necessarily lead to lower interbank rates as the central bank might use other tools to make any changes rate neutral. However, it is likely that the interbank rate will be relatively lower because the RRR reflects a mild loosening bias. The cut is likely related to 1. slower than expected money and credit growth in March which raised concerns about demand growth sustainability. We expect April money and credit growth to show a rebound as the central bank may use quantitative tools to make sure money and credit growth does not decelerate meaningfully further, 2. rising risks of trade tensions, especially in light of ZTE sanctions and recent retaliation on sorghum, and 3. lower than expected inflation which lowered the perceived need to tighten policy, 4. lower than expected March data on exports, IP and FAI may also have contributed.

The central bank emphasised 4 factors in the announcement 1. this is to swap MLF, 2. this is a targeted cut though it effectively is a near system-wide cut as only the smallest financial institutions are exempt from the cut as they already enjoy a much lower RRR of 11% or 12%, 3. RRR needs to be kept at a relatively high level to limit financial risks. It is arguable whether a high RRR is really necessary in maintaining financial stability. 4. neutral policy stance remains unchanged. We believe these statements are to anchor people’s expectations about future loosening measures including RRR cuts. Investors should not expect any drastic loosening of the nature that we saw in earlier years. With activity growth remaining firm and unemployment rates low we see no urgency to loosen aggressively at least so far.This also lowers the costs of funding for commercial banks as MLF costs are high (3% or above). Commercial banks also may be more willing to lend as RRR is often viewed as a more permanent source of funding.