China: PBoC Cuts Reserve Requirement by Another 50bps

• The People's Bank of China (PBoC) on Saturday cut the reserve requirement ratio (RRR) by 50bps for the second time in less than three months. The RRR cut has been expected for some time and, if anything, the pace of monetary easing has been more cautious than expected. PBoC's cautious approach was last week underscored when it cut its target for money supply M2 growth to 14% for 2012 from 16% for 2011.
• PBoC's cautious approach reflects on the one hand that PboC still feels confident that the economy will manage a soft landing, albeit there are downside risks, and on the other hand, it will still have to manage inflation expectations. We still expect two more 50bps cuts in the RRR in H1 12, but do not expect the leading interest rates to be cut.

Details

People's Bank of China (PBoC) on Saturday announced that that the reserve requirement ratio (RRR) for commercial banks effective from 24 February will be cut across the board by 50bps. For the major banks the implication is that that the RRR will be cut from 21.0% to 20.5% and for small banks the RRR will be cut from 19.0% to 18.5%. This is the second cut in the RRR in less than three months (the last 50 bps cut was announced on 30 November last year), and we estimate that the cut will add about CNY400bn in interbank liquidity.

Assessment & Outlook

This RRR cut this weekend can hardly be regarded as a surprise and, if anything, PBoC has been a bit more reluctant than expected in cutting the RRR for the second time. The general view, including ours, was that PBoC would announce the second RRR cut ahead of the Chinese New Year holiday that started on 22 January. The unexpected large acceleration in inflation in January from 4.1% y/y to 4.5% y/y might be part of the explanation for PBoC's cautious attitude, albeit the acceleration in inflation appears to be just a temporary blip in connection with an early Chinese New Year holiday. This has so far been confirmed by the weekly data for agricultural commodity prices released by China's Ministry of Agriculture. These data show substantial declines in both meat and vegetable prices in the first two weeks in February and at the current juncture suggest that CPI inflation will drop below 4% y/y in February from 4.5% y/y in January. Evidence that the downward trend in inflation remains intact might have been important for the timing of this weekend's RRR cut.

However, we believe it would be wrong to regard this weekend's RRR cut as a move by PBoC towards a more substantial easing bias in monetary policy. As mentioned above, the pace of monetary easing has, if anything, been more cautious than expected. This was not least the evidence, when PBoC announced that the target for M2 money supply growth in 2012 would be cut to 14% y/y from 16% y/y last year (we expected the target to be unchanged at 16%). As seen in the chart, current M2 growth is only slightly below target, suggesting that monetary policy will only have to be eased slightly in the coming months. The buzzword used to describe monetary policy by the policy makers also continues to be “prudent” (which usually means it will remains slightly tight) and that monetary policy will only be “fine tuned”.

Hence, we continue to expect only cautious monetary easing supplemented with some minor fiscal easing. We expect the RRR to be cut by another 50bps twice in H1 12, with the next cut in early April. We do not expect the leading interest rates to be cut. However, with inflation continuing to decline, China should be in a position where it can ease both monetary and fiscal policy more aggressively if needed.