Chinese Economic Update – 02 March 2015

Chinese policy makers cut rates again to fend off disinflation and deflation

On Saturday night Chinese policy makers took the world by surprise for the second time in just a few short months when they announced a 25 basis point reduction to both the lending and deposit rates, which now stand at 5.35% and 2.5% respectively.

The move by the People’s Bank of China came in response to mounting concerns over disinflation and the potential for this to become entrenched, which could ultimately lead to deflation.

While any rate cut represents a significant policy action, the PBOC’s recent move is more than that as it marks a clear shift in the thinking of Chinese rate setters.

This is that, until now, policy in China was set according to the pace of GDP growth. However, the reasons cited for Saturday’s cut to rates indicate that Chinese policy makers are now beginning to pay greater attention to inflation (0.8%) and the central bank’s inflation target (3.5%).

Although the timing of Saturday’s action came as a surprise, the fact of that the PBOC has cut rates further was to be expected, given the pace of the slowdown within the economy and the fact that inflation remains a considerable distance below the PBOC’s 3.5% target; at just 0.8%.

Further to this, the path of inflation across both developed and emerging economies has taken a sharp downward turn during the last nine months.

Although much of this is the result of a marked adjustment in energy prices, there are also some areas where disinflation and deflation are thought to be the product of a lacklustre economic environment; particularly in parts of Europe.

Consequently, we expect that the PBOC will remain on a path toward easier policy as interest rates remain too high in China given the current level of inflation and the challenges facing the Chinese economy.

Furthermore, we also believe it is likely that both Chinese officials will lower the growth target for 2015 this month, from the current 7.5%, down to 7.0% . This could also be accompanied by a reduction to the inflation target, which currently sits at 3.5%, down to 2.5%.

We expect these moves are likely to be announced during or after the meeting of China’s top legislative body, the National People’s Congress, later this month.


The takeaway

The obvious implications of recent events are ever easier monetary policy in China, which should help to support Chinese equity markets as well as investor sentiment toward the prospects for global growth in 2015.

However, we caution that since the initial interest rate cut by the PBOC in November last year, the Shanghai Composite Index has gained just over 37%. Such a rapid acceleration, combined with the prospect for the government to announce a lower growth target for the year, could lead Chinese markets into a correction over the near term.

If this proves to be the case we do not believe that it would signal the end of the bull run in Chinese equities. This is because lower rates in Asia could be expected to eventually drive greater numbers of investors into equity markets in their search for yield, while the outlook for developed economies in 2015 also remain relatively positive, which should also help to support sentiment toward the SSE Comp over the medium term.

SSE Index / Daily Intervals





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