China’s decision to cut its base interest rate on November 21 caught many investors off guard and gave a boost to flagging commodities prices.
On the first day of trading following the cut, which saw the interest rate reduced for the first time in two years, oil rose back above $80-per-barrel.
The move, which resulted in one-year lending being reduced 40 bps to 5.6%, was largely viewed as an attempt to stave off deflationary pressures and alleviate stress caused by low growth numbers.
However, with rumours of a second cut on the cards, many leading investors have questioned the decision, with former UBS chief economist George Magnus stating the government had ‘blinked’ at the first sign of stress.
But, what is the long-term impact? Citywire Global canvassed leading managers focused on China itself, the wider emerging markets and the energy and commodities sector to uncover the extent of the cuts.
The China view
The decision by the People’s Bank of China (PBOC) caught markets off guard but is not the aggressive move many investors may interpret it as, said Vanessa Donegan, head of Asian equities at Threadneedle.
'This move should not come as a surprise as the on-going relative strength of the Renminbi (+15% on a trade-weighted basis since the start of 2013) has meant that China has been effectively importing deflation and falling inflation has in turn caused the real cost of borrowing to rise for corporates.'
'Rate cuts in China are traditionally viewed as a sign of an aggressive easing stance but the PBOC’s asymmetric move, which gave banks greater freedom to set deposit rates, should be viewed as broadly consistent with their stated policy of targeted easing, which has to date focused more on replenishing interbank liquidity.'
'The cut in the benchmark lending rate is a more direct way of lowering corporate borrowing costs. Should a more aggressive easing of monetary policy be required to avoid a hard landing for China’s economy, the PBOC is likely to resort to a cut in the required reserve ratio (RRR) for banks, traditionally their main tool for managing the money supply.'
The EM view
For Jan Dehn, head of research at emerging markets specialist Ashmore, the rate cut serves as a major signal of how pivotal policies geared towards the country’s bond market will become.
'The move towards consumption-led growth is slowing the overall economy and putting downward pressure on inflation. The new growth model also requires brand new policy levers to manage the economy, particularly a greater reliance on interest rates.'
'PBOC’s latest policy moves achieve two things: first, they help the economy though its economic transition; second, they advance the objective of interest rate liberalisation. The latter is ultimately far more important than the former, in our view.'
'The Chinese bond market is destined to be the main transmission mechanism for PBOC rate changes and interest rate management is in turn going to be China’s principal instrument of macroeconomic policy in the future (just as it is in most developed economies).'
'That is why interest rate liberalisation and the development of the Chinese bond market, including opening of the market to foreign investors, is so key.'
The energy view
'Chinese economic trends affect oil prices and both have been weak this year. The rate cut last week will improve the economic outlook and, in all likelihood, will be good for crude oil prices and energy equities. Chinese energy equities outperformed the market on the news and, despite the economic weakness, have actually been strong performers in a global energy context during 2014.'
'However, if there is one ‘near certainty’ in the energy world - it is the fact that Chinese transportation demand will continue to grow. There is no real substitute for gasoline, despite a move to more electric cars and more efficient vehicles, and we expect the Chinese car fleet to go from 80m vehicles in 2010 to nearly 500m vehicles in 2030. This demand growth cannot be met entirely by gasoline; we fully expect to see higher oil prices to force a switch to other sources of fuel for transportation.'