China cuts interest rates

China cuts interest rates – positive for risky assets particularly emerging markets and commodities

The Peoples Bank of China (PBoC) today cut its leading interest rates. The one-year benchmark deposit rate was cut by 25bp to 2.75% and the one-year benchmark lending rate was cut by 40bp to 5.6%. As the lending rates have largely been liberalised, the oneyear depot rate is now the most important of the two benchmark interest rates.

While it was clear that there was a slight easing bias in monetary policy in China, the interest rate cut was nonetheless a bit of a surprise. It suggests that China now has a more substantial easing bias in monetary policy and the government’s attempt to contain credit growth will be loosened somewhat in coming months. Hence, supporting growth now appears to be a higher priority.

The implication of today’s interest rate cut is that the Chinese growth manufacturing PMIs and growth have probably bottomed out and should start to improve in Q1 when investment demand and particularly the property market will start to rebound. The interest rate cut is particularly important for the property market where the 40bp cut in the benchmark lending rate is still important for mortgage interest rates. The growth outlook is definitely more positive for H1 15. However, we do not expect to see a sharp rebound in growth next year as the government will still be focused on managing financial risk and securing sustainable credit growth. Hence, the PBoC will continue to ease only cautiously and we do not expect it to cut rates further. In addition, China remains in a structural slowdown, which will continue to weigh on growth further ahead.

The interest rate cut is extremely positive for risk sentiment and risky assets in general in financial markets and it is particularly positive for emerging markets and commodities. Hence, it should help commodity and Emerging Market currencies like the Norwegian krone, the Australian dollar, Canada dollar, Brazilian real, Mexican peso and the South African rand.

Base metal prices and oil prices have reacted instantly to the news with Brent up 50%. An integral part of the recent weakness in commodity markets has been the weakness in the Chinese economy – the rate cut should support Chinese growth and thereby support a recovery in commodity prices. The oil market in particular has been longing for support from the demand side since the sharp decline in prices started in early September. The rate cut will, therefore, be an important factor in supporting the expected recovery in oil prices. Therefore, the news supports our call for a higher oil prices next year – in 2015 we forecast Brent at USD94/bbl.