Economists generally expect US interest rates to rise to between 3.5 and 3.75 per cent, up from the current range of 2.25 to 2.5 per cent. China’s benchmark rate currently stands at 3.65 per cent.
This is bad news for China because it narrows the room for cuts even further at a time when China’s economy needs it the most
“This is bad news for China because it narrows the room for cuts even further at a time when China’s economy needs it the most,” said Alicia Garcia-Herrero, chief economist for Asia-Pacific at Natixis.
“The [People’s Bank of China], however, will need to tighten capital controls on outflows even further.”
China’s economy is slowing as a result of its strict coronavirus controls, downward pressure on the housing sector and power shortages in Sichuan caused by the ongoing drought.
Growth forecasts for China this year were slashed by Standard Chartered, Goldman Sachs and Natixis earlier this month.
China rate cuts further widen US policy gap, with all eyes now on Fed
China rate cuts further widen US policy gap, with all eyes now on Fed
This month China cut a key policy interest rate by 10 basis points in August – the first cut since January – in an attempt to give the economy some impetus.
The People’s Bank of China (PBOC) unexpectedly lowered the rate of one-year medium-term lending facilities to 2.75 from 2.85 per cent in a 400 billion yuan (US$58.3 billion) sale.
Powell’s comments signal a wider policy gap between China and the US. China is trying to buck the trend by cutting rates to boost its economy while most central banks worldwide have raised interest rates in tandem with the US Federal Reserve.
The threats of recession in the West due to the rate hike and market volatility also overshadows Beijing’s efforts to rein in the slowdown.
The main issue faced by the Chinese central bank is to stabilise economic growth. That explained its recent rate cuts
Markets fell after Powell’s speech, with the Dow Jones Industrial Average trading down more than 1,000 points on Friday.
Yang Delong, chief economist of Qianhai Kaiyuan Fund, said Beijing will continue to prioritise stabilising its economy and disregard the gap with the West.
China’s central bank has a different agenda from the US Federal Reserve’s preoccupation with curbing inflation, and its recent policy focus on credit expansion is now challenged by eroding market confidence, he said.
“The main issue faced by the Chinese central bank is to stabilise economic growth. That explained its recent rate cuts,” he said.
“How to finish the last mile of lending money to companies or consumers will be one of its key tasks.”
Why is China facing a power crisis, and what does it mean for the economy?
Why is China facing a power crisis, and what does it mean for the economy?
Earlier this week, PBOC governor Yi Gang ordered major state-owned commercial and policy banks to shoulder a leading role in stabilising credit supply and take urgent actions to consolidate the economic recovery.
Capital may be attracted to leave China to seek higher return in the US if the US Federal Reserve accelerates its rate increases and “capital outflows will likely pick up in the second half”, said Zhang Zhiwei, chief economist at Pinpoint Asset Management.
Still that would not be “a major concern for the economy,” he said, adding that domestic issues like Covid-19 and the property slump are more consequential.
“Capital outflow is indeed one of the concerns for China, but not the main concern,” said Dong Jinyue, senior China economist at BBVA Research.
“Unlike other major economies, China has a comparatively closed capital account, capital inflows and outflows have to strictly follow schemes such as [Qualified Foreign Institutional Investor, Renminbi Qualified Foreign Institutional Investor, and some Connect Schemes] with quotas imposed.”
The yuan’s exchange rate is still generally managed by the central bank, she added, and China’s business cycle not being synchronised with the United States and European Union means its stock market is still attractive for global asset allocation.
Zhang said China does not have a balance of payments problem as it has a persistent trade surplus and overseas spending is not constrained.
According to Chinese customs data, the country’s total trade surplus hit an all-time high of US$101.26 billion in July, compared with US$97.94 billion in June.
But Garcia Herrero held a different view on overseas spending.
“I would even say, [tighter capital controls] are not going to help open the border, especially for Chinese to travel abroad,” she said.
Services such as tourism and overseas education were a major source of outflows in 2019, she added, it will put additional pressure on the yuan if these activities are allowed now.
Additional reporting by Mark Magnier and Frank Tang
As a seasoned economic analyst with a profound understanding of global financial markets and central banking policies, I'm well-equipped to dissect the intricate dynamics highlighted in the provided article. My expertise is grounded in a comprehensive grasp of economic indicators, central bank strategies, and the interconnectedness of global economies. Let's delve into the key concepts featured in this piece:
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Interest Rate Projections:
- The article discusses economists' expectations of a rise in US interest rates to a range of 3.5 to 3.75 percent from the current 2.25 to 2.5 percent. This projection is crucial as it sets the stage for various economic activities, impacting borrowing costs, investment decisions, and currency valuations.
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China's Benchmark Rate:
- China's benchmark interest rate is revealed to be 3.65 percent, slightly below the anticipated range for US rates. The proximity of China's rates to the upper end of the expected US range is a significant factor in the economic narrative.
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Impact of Rate Changes on China's Economy:
- The article highlights the challenging situation for China, suggesting that the expected rise in US interest rates constrains China's ability to implement rate cuts to stimulate its slowing economy. This is particularly concerning given the economic headwinds faced by China, including coronavirus controls, housing sector challenges, and power shortages.
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People's Bank of China's Response:
- The People's Bank of China (PBOC) is noted for its recent policy move, cutting a key interest rate by 10 basis points in an attempt to provide a boost to the economy. The central bank's decision to lower the rate of one-year medium-term lending facilities is a response to the economic challenges faced by China.
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Policy Gap between China and the US:
- The article emphasizes the widening policy gap between China and the US, with the former cutting rates to stimulate its economy while the latter, represented by the US Federal Reserve, is on a tightening trajectory to curb inflation.
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Market Reaction and Economic Stability:
- The impact of the US Federal Reserve's stance on markets is evident in the article, with the Dow Jones Industrial Average experiencing a significant drop. Maintaining economic stability is a priority for China, and the article suggests that Beijing is willing to prioritize its domestic economic concerns over concerns about the policy gap with the West.
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Capital Flows and Economic Concerns:
- The risk of capital outflows from China to the US is highlighted, especially if the US Federal Reserve accelerates its rate increases. The article notes that while capital outflows are a concern, domestic issues such as COVID-19 and the property slump are deemed more consequential.
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Capital Controls and Yuan's Exchange Rate:
- Tightening capital controls is proposed as a measure by the People's Bank of China to prevent excessive capital outflows. However, experts disagree on the severity of the impact, with some suggesting that China's closed capital account and managed exchange rate may mitigate the risks.
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Trade Surplus and Currency Management:
- China's persistent trade surplus is mentioned, and it is highlighted that the country does not face a balance of payments problem. The article underscores the managed nature of the yuan's exchange rate and the attractiveness of China's stock market for global asset allocation due to its distinct business cycle compared to the US and European Union.
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Concerns about Overseas Spending and Yuan Pressure:
- There's a divergence of opinions on the effectiveness of tighter capital controls, with some experts suggesting it might not necessarily open borders, especially for activities like tourism and overseas education. The potential impact on the yuan is discussed, particularly if these outflow activities are permitted.
In conclusion, my in-depth understanding of these concepts enables me to navigate the complexities of global economic dynamics and provide valuable insights into the challenges and strategies adopted by major economies like the US and China.
