China: Rate cuts to support growth

The PBOC cut the MLF rate from 2.75% to 2.65% as recovery momentum faded in May, which is consistent with the 7D repo cut earlier this week.
Group Research, Samuel Tse, Thomson Law15 Jun 2023
  • The PBOC cut the MLF rate from 2.75% to 2.65% as recovery momentum continued to moderate.
  • Nuanced stimulus to forestall further CNY depreciation.
  • We expect there will be a 10bps cut of 1Y and 5Y LPR next Tuesday and in 3Q, respectively.
  • We project USD/CNY to hold around 7.18 in the next quarter.
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The PBOC cut the MLF rate from 2.75% to 2.65% as recovery momentum faded in May, which is consistent with the 7D repo cut earlier this week. We expect the authority to cut the rate by another 10bps in 3Q. For 1Y and 5Y LPR, there will be a 10bps cut next Tuesday and in 3Q, respectively. USD/CNY is projected to weaken to the 7.18 threshold in the next quarter.

Retail sales growth eased

Advancement of retail sales retreated from 18.4% YoY in April to 12.7% in May. F&B sales rose by 35.1% YoY, compared to 43.8% in April, due to highly charged tourism during the week-long Labour Day holiday. However, this will likely ease as consumers have probably already taken most "revenge travel" trips, as evidenced by the cooling services PMI. Also, consumer goods sales, which accounted for 90% of total retail sales, grew much weaker than catering.  Amongst all, property market-related items such as decoration shaved by 14.6%. Auto sales also retreated from 38.0% to 24.2%. As a result, weakening consumption translated into benign core inflation around 0.6%-0.7% YoY over the past four months. Hopefully, the cut in deposit rates of the six state banks could help unleash the spending power of record high new saving deposits.

Production is easing on external demand

Factory production growth fell from 5.6% YoY in Apr to 3.5% in May on easing exports. Outward shipment plummeted by 7.5%, compared to an advancement of 8.5% last month. Manufacturing PMIs contracted by two months in a row, with New Export Orders sub-PMI exemplifying a visible decline. Ongoing rate hikes in advanced economies such as US and EU will dampen their demand for Chinese products. Manufacturing PMIs of these economies are retreating too. Negative economic surprise has also been growing in the Eurozone. As such, industrial profit will likely contract further. This mirrors the falling Producer Price Index.

Strong state but subdued private investment

Fixed asset investment slowed further from 4.7% YoY YTD in Apr to 4.0% in May. That of SOEs maintained its uptrend of 8.4%, albeit slower than the 9.4% in Apr. Infrastructure, and electricity & gas growth were much faster than the headline figure. In the high-end manufacturing sector, computer and communication, electrical machinery & equipment, and automobiles, leapfrogged by 10.5%, 38.9%, and 17.9%, respectively. Reportedly, the authority may provide tax breaks to sectors such as new material, chips, artificial intelligence, and bio-pharmaceutics.

On the contrary, private sector investment recorded the first contraction of 0.1% YoY YTD since COVID. The plunge in real estate investment extended from 6.2% in Apr to 7.2% in May. Weekly primary market transaction and project launch is only 55% and 37% of their respective peaks in 2021. According to China Real Estate Information Corp., the sales fell by 14.3% MoM in May. Price of 70 Cities Newly Built Commercial Residential Buildings eased from 0.32% MoM to 0.10% in May. As such, the investment appetite of developers is abating except for top 1st tier cities. Bought-in rate of land auctions in Beijing, Shanghai, and Shenzhen stayed at 0% in the first 5 months. The percentage of land sold at a premium for these cities reached 70-80%. The performances of 2nd tier cities such as Chengdu and Chongqing were much weaker. Land auctions in Tianjin, the neighbouring province of Beijing, remained subdued. Only 15% of the land sold fetched a premium. Reportedly, the government will push forward targeted support policies such as cutting down payment in non-core neighbourhoods of major cities, lowering agent commissions on transactions and relaxing restrictions on residential purchases. We also expect banks to cut the 5Y LPR by 10bps next Tuesday and in 3Q to support the property market. Hopefully, these measures could help restore confidence in the property market marginally.

Credit growth moderated

Against this backdrop, credit demand grew slower than money supply. Aggregate financing growth dipped from 10.3% YoY in Apr to 9.8% in May, below the 11.6% in M2. Meanwhile, new medium and long-term corporate loan growth retreated from 151% to 39%, in tandem with moderating private investment. Reflecting the tepid property market, new medium to long-term household debt (a proxy for mortgages) plunged by 12.8% YoY YTD. Loan demand may continue to soften in the months ahead. This is evidenced by the decrease in interbank rates. DR007 dropped from a one year high of 2.18% in early May to 1.87% of lately.

Nuanced stimulus to forestall further CNY depreciation

PBOC Governor Yi Gang hinted there would be counter-cyclical adjustments to support the economy. However, the stimulus package will likely be nuanced, and we expect only another mild 10bps cut in MLF rate. After all, an aggressive rate cut will weaken the CNY exchange rate amid Fed’s rate hike cycle. The Fed could raise the target rate by another 25bps in July and keep it at this level for an extended period. The spread between China-US government bonds is now widening and adding downward pressure to the CNY.

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Samuel Tse 謝家曦

Economist - China & Hong Kong 經濟學家 - 中國及香港

Thomas Law

Summer Analyst

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