Maybank FX Note: CNH - Rate Cut – Not Only To Calm Markets - 29 Jun 2015

CNH : Rate Cut – Not Only To Calm Markets

PBOC Cuts Benchmark Interest Rate and RRR for Some Banks

China cut benchmark interest rate and lowered RRR for selective lenders on Sat. Lending rate was lowered by 25bps to a record low of 4.85% while 1-year deposit rate will fall by 25bps to 2%. RRR for some lenders including city commercial and rural commercial banks was cut 50bps.

To Sooth Market Sentiments

The cut was timed right after a pretty sharp correction in the stock markets amid some speculation that China might be at the end of an easing cycle. The government officials are making it very clear that no, it is not. With this move, PBOC signals that easing cycle is far from over in the hope of stabilizing the equity markets and maintaining the positive wealth effect and household demand. Hope rests on retail sales and property growth to keep growth around 7%.

Ahead of Lacklustre Jun Data

The great disconnect between Chinese equities and fundamentals will continue to prevail. Data has not been great for Apr and Jun despite the 2 RRR cut and 2 interest rate cut, each delivered around a month apart since Feb. Industrial production, in particular, crawled at an anaemic 6 odd % and  HSBC PMI-mfg is still sub-50. Rate cuts at this point suggest that data for Jun will not impress as well.

And Suppress Real Interest Rates

A simultaneous delivery of RRR cut and interest rate cut is rare and apart from soothing sentiments at home, the officials is likely meant to suppress real financing rate. 3-month SHIBOR and 7 day repo rates have been turning higher as recent government bond issuance also tightened liquidity.

Boost Credit Growth

Few would disagree that China still needs help to boost credit growth and the removal of loan to deposit ratio would also be able to aid that aspect. Last week, China also injected liquidity through open market operations, the first injection of liquidity since early Apr. Banks are still unwilling to loan to smaller companies due to credit concerns and that explains the selective RRR cut for city commercial and rural commercial banks. Moving forward, we do not rule out more cuts to the RRR and interest rates though we think there is a real need for fiscal stimulus in order to plug the gap in the current system of financial intermediation that is still inefficient.

CNY Still Steady 

USDCNY was fixed merely 31 pips higher this morning despite the gap up in the DXY index. Although the US-China Statement saw a supposed pledge by China for limited FX intervention, the yuan is still largely guided by the daily fixing and USD/CNH reverses out earlier gains to trade around 6.2125 at last sight. We expect the yuan to remain within familiar ranges as China continues to maintain a steady yuan to up its efforts for entry into SDR basket as well as to stem capital outflows. Shanghai Composite saw mild gains this morning while Shenzhen Composite remains in deep red, down -2%. Current risk aversion has not spared domestic equities and that could keep yuan on the backfoot. Downside is still limited with USD/CNY and USD/CNH still guided within 6.20-6.22 range by the daily fixing.