Will China’s interest rate cut actually work?


The People’s Bank of China has cut its main interest rate by 0.25 percentage points to 4.6 per cent in an attempt to boost its economy after days of market turmoil.

Chinese markets continued their downward fall today, with the Shanghai Composite opening around 7 per cent down on yesterday’s close. Since its peak in June, the Shanghai market has lost nearly 40 per cent in value.

In a statement posted on its website, the People’s Bank of China said the move to cut interest is intended to reduce “the social cost of financing to promote and support the sustainable and healthy developments of the real economy”.

The rate cut, which will be effective on Wednesday, is the fifth by the Chinese central bank since November 2014.

Premier Asset Management investment manager Jake Robbins says the interest rates cut is not the first, but it is “debatable” if this time a rate cut “will actually work”.

He says: “Chinese companies have a lot of debt, local authorities have a lot of debt, which has led to a lot of over-capacity, which is why we are seeing such a weakness in prices. What authorities don’t want to do is encourage people to build more capacity to borrow cheaply.

“The Chinese authorities were forced into such a position to almost cause this rally in the market…The move will be taken positively tomorrow but it does suggest, again, that the authorities don’t have control on the market and the economy.”

Royal London’s chief economist Ian Kernohan says the move from the PBoC shows authorities continue to be keen to support the economy.

He says: “The move from the central bank of China is connected to what happened in the last few days in the markets. The move has had market sentiment effects as we’ve seen a sell-off of government bonds as well as a rally in equities.”

After today’s move from the PBoC, the FTSE 100 jumped 3.3 per cent, following its drop of 2.4 per cent in yesterday’s early trading.

Yesterday the FTSE had fallen to 6,042 after China’s Shanghai Composite index fell a massive 8.49 per cent to close at 3,209.91, on top of a 12 per cent drop over the past week.

However, the Government intervention may not be over. Kernohan believes the central bank of China could still go further on cutting interest rates as authorities are focusing on economic growth rather than financial reforms.

He adds: ”My feeling is that up to now, authorities were reluctant to have too much stimilus because they wanted to balance the economy with reforms. However, what they didn’t want to do is to over-stimulate the economy in the way they did in 2008/09.

“They are more concerned about growth now, and maintaining that growth rate, rather than worrying too much on financials.”

In mid-July Chinese GDP growth was estimated at 7 per cent for 2015, according to the Chinese National Bureau of Statistics, but current market conditions mean this target may be unattainable.

Fidelity Worldwide Investment global economist Anna Stupnytska says the current state of the economy is “certainly not consistent with this year’s growth target” as well as not being consistent with the labour market stability.

She says: “[The labour market stability] is the real reason why more policy action is likely. I don’t expect a big bang stimulus package along the lines of what we saw in 2009 as that would mean a step back in the whole reform effort, but I do believe we will see more monetary and fiscal support. Today’s move to cut interest rates and [the Required Deposit Reserve Ratio] is certainly a step in the right direction.

“But while this might help sentiment, it’s not enough to reverse the ongoing slowdown in China’s growth. Some stabilisation in activity is probably the best case scenario. A sharp rebound is unlikely.”