Stressed Beijing will buck Fed's tightening trend

3 minute read

A giant screen displays news footage of Chinese President Xi Jinping delivering a speech, on New Year's Eve at a shopping mall in Beijing, China December 31, 2021. REUTERS/Florence Lo

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HONG KONG, Jan 17 (Reuters Breakingviews) - The Chinese economy is declaring independence from the U.S. Federal Reserve Board. Gross domestic product grew 8.1% in 2021, well above target, but activity slowed sharply toward the end of the year, so the central bank surprised markets with a rate cut on Monday morning read more . Low inflation and a strong yuan give Beijing room to decouple further.

A robust export-driven recovery in the first half of 2021 gave Chinese leaders leeway to push through painful reforms even as their stringent zero-Covid policy suppressed domestic consumption. But the situation deteriorated alarmingly therafter. In the fourth quarter growth slowed to 4% year-on-year, while December retail sales fell to 1.7%, missing estimates by a wide margin. Power generation, a useful proxy for overall demand, was down 2% year-on-year for that month.

President Xi Jinping may have recognised the risk to stability, but easing has been underwhelming, in part because of the campaign to curb debt in the real estate sector. Total social financing – the broadest credit measure – missed forecasts last month, reflecting sluggish borrowing demand.

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With U.S. inflation rising and tapering looming, however, the People’s Bank of China is well-positioned to head in the opposite direction. Core inflation came in at just 1.2% in December. With exports surging at an average of over 20% every month, the PBOC is more worried about the yuan, which soared 8% to a six-year high against a basket of currencies in 2021. There are upsides to a strong currency, but it could start putting exports at risk, and the need to ease is greater as officials scramble to contain fresh Covid-19 outbreaks.

Thus Monday’s surprise cut to the medium-term lending facility and short-term bond repurchase guidance rates, which will probably be followed by another cut to the benchmark Loan Prime Rate on Jan. 20.

To be sure, lower rates might not find much traction if the central government cannot spur investment. Local government bond issuance disappointed in January, as cities struggle to find projects that generate returns instead of wrecking balance sheets. Fiscal support will take time to show up. But with so many people and companies struggling to stay afloat, the PBOC can throw them a cheaper credit lifeline at least, and not worry about the Fed.

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CONTEXT NEWS

- China’s gross domestic product grew 4.0% in the fourth quarter compared to the same period the prior year, slowing from 4.9% in the third quarter, data from the National Bureau of Statistics showed on Jan. 17. Analysts polled by Reuters had expected it to grow 3.6%.

- The People's Bank of China said on the same day that it would lower the interest rate on 700 billion yuan ($110.19 billion) worth of one-year medium-term lending facility (MLF) loans to some financial institutions by 10 basis points to 2.85% from 2.95% in previous operations. It is the first such cut since April 2020, Reuters reported.

- The central bank also lowered the borrowing costs of seven-day reverse repurchase agreements, or repos, by the same margin to 2.10% from 2.20%.

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Editing by Pete Sweeney and Thomas Shum

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