China central bank keeps powder dry after Fed rate cut, but more easing expected

SHANGHAI (Reuters) - China’s central bank kept its main policy rates on hold on Thursday, opting not to follow an overnight benchmark rate cut by the U.S. Federal Reserve as policymakers wait to see if earlier support measures start to stabilize the economy.

FILE PHOTO: Headquarters of the People's Bank of China (PBOC), the central bank, is pictured in Beijing, China September 28, 2018. REUTERS/Jason Lee/File Photo

But market watchers say continued support is still needed, and expect more modest forms of policy easing from the People’s Bank of China (PBOC) in coming months if pressure on the economy persists.

Amid mounting worries about risks to global growth, the Fed lowered its benchmark rate by a quarter-point on Wednesday, as expected, but the head of the U.S. central bank ruled out a long series of cuts.

Though China’s central bank does not always follow the Fed’s moves in lockstep, some analysts had thought a token PBOC cut, likely in one of its short-term rates, was a possibility.

However, no move was apparent by midday on Thursday. The PBOC refrained from daily open market operations (OMOs) early in the session, saying banking system liquidity was “reasonably ample”.

“The PBOC skipped OMOs and hence there was no rate adjustment,” said Frances Cheung, head of Asia macro strategy at Westpac in Singapore.

“The market may need to wait until mid-August when the next tranche of medium term lending facility (MLF) matures to see if there is any action. Arguably they can adjust policy parameters anytime, and are not constrained by any meeting schedule, but we see no pressure on OMO rates.”

China’s central bank has already been quietly guiding borrowing costs lower over the past year, mainly through hefty liquidity injections. Last week, it shifted more funds into a lower-cost, medium-term lending scheme aimed at helping struggling smaller firms.

While heading off a sharper economic slowdown remains Beijing’s top priority, officials fear easing too aggressively could fuel debt and financial risks, according to government advisers involved in internal policy discussions.

Central bank governor Yi Gang also said recently that current interest rate levels are appropriate.

China’s economic growth slowed to a near 30-year low in the second quarter as demand at home and abroad faltered in the face of mounting U.S. trade pressure. But June activity data offered some signs of improvement, possibly in response to higher government infrastructure spending.

Business surveys for July released this week suggest pressure on China’s factories is easing slightly, though activity is still contracting and analysts caution it is too early to tell if the economy is bottoming out yet.

With household debt climbing and property prices on the rise, policymakers are very cautious about the risks of further loosening, said Zhu Chaoping, global market strategist at J.P. Morgan Asset Management in Shanghai.

But analysts still expect more measured support from the PBOC in the form of additional liquidity injections.

Further cuts in banks’ reserve requirement ratios (RRR) are seen in both this quarter and next to direct funding to parts of the economy that need it most. The PBOC has already cut RRR six times since early 2018.

“The PBOC is still likely to maintain its targeted operations in the future to support investment growth in the real economy, but the efficacy is likely to decrease,” Zhu said.

A system-wide “universal” RRR cut, or a policy rate cut, is still possible by the end of the year, Zhu added.

China could also effectively lower lending rates through long-dicussed reforms, such as unifying its benchmark and market rates, he said, though others believe such an overhaul will need more time to develop.

In the meantime, the PBOC has a large range of policy tools and rates to chose from.

Many traders are closely watching 7-day reverse bond repurchase agreements via open market operations, a type of short-term loan the central bank uses to increase liquidity and influence other rates in the banking system.

The interest rate on the seven-day tenor was 2.55 percent on Wednesday.

The PBOC has not cut its benchmark lending rate since the last downturn in 2015.

Reporting by Winni Zhou and Andrew Galbraith; Editing by Kim Coghill