China Surprises with Modest Rate Cut Amid Growing Yuan Risks

China Adjusts Benchmark Lending Rate Amid Economic Concerns

SHANGHAI/SINGAPORE – China has lowered its one-year benchmark lending rate as part of ongoing efforts to boost credit demand. However, the decision to keep the five-year rate stable has caught markets off guard, raising worries about a weakening currency.

The recovery of China’s economy is faltering, largely due to a downturn in the property market, sluggish consumer spending, and diminishing credit growth. This situation intensifies calls for further policy support.

Analysts suggest that the declining value of the yuan limits Beijing’s ability to implement deeper monetary easing. If the yield gap between China and other major economies widens further, it could lead to significant yuan sell-offs and a potential outflow of capital.

The one-year loan prime rate (LPR) has been reduced by 10 basis points to 3.45%, down from 3.55%. In contrast, the five-year LPR remains unchanged at 4.20%. A recent poll of market experts anticipated cuts to both rates, with many expecting a 15 basis point reduction in the one-year rate.

"China may be cautious in the extent of rate cuts due to concerns about the yuan’s downward pressure," noted Masayuki Kichikawa, chief macro strategist at Sumitomo Mitsui DS Asset Management. "Authorities prioritize stability in the currency markets."

Most loans in China are pegged to the one-year LPR, while the five-year rate influences mortgage pricing. In June, both rates were cut to help stimulate the economy.

The yuan traded lower at 7.3078 per dollar compared to 7.2855 previously, while major stock indices also declined. This year, the yuan has depreciated by nearly 6% against the dollar, making it one of Asia’s weakest currencies.

The recent reduction in the one-year LPR follows the People’s Bank of China’s (PBOC) unexpected cut to its medium-term policy rate last week, which typically indicates future adjustments to lending rates.

In its report on second-quarter monetary policy, the central bank reaffirmed its goal of maintaining ample liquidity and implementing precise policy measures to support economic recovery despite rising challenges.

Market analysts were surprised by the steady five-year rate, given the ongoing troubles in the property sector and increasing default risks among developers. "The decision to maintain the five-year LPR signals that banks might be unwilling to reduce rates and risk affecting their profit margins," explained Ken Cheung, chief Asian FX strategist at Mizuho Bank.

Cheung added that this unexpected outcome could present challenges for China’s growth and impact the yuan’s exchange rate. The central bank has indicated that it will enhance credit policies for the property sector and coordinate financial support to address local government debt issues, according to a statement released Sunday.