The PBoC's decision to use its big guns saves AUDUSD

The People’s Bank of China (PBoC) unexpectedly announced on Friday that it is cutting its benchmark rate for the first time since 2012, which sent investors flocking towards the commodity-backed Australian dollar. Prior to this, AUDUSD was hovering precariously close to an important support zone around 0.8600. If there pair fell through here there wouldn’t be much technical support until it reached an all-important support zone around 0.8550.

China pulls out the big guns

China’s central bank cut its one-year lending rate by 40 bps to 5.6% and its one-year saving rate to 2.75% from 3.00%. This suggests that Beijing is concerned about the health of the economy as it struggles with unimpressive levels of economic activity and falling property prices. Recent economic indicators from within China have consistently come in below expectations, with key manufacturing and industrial productions figures showing weakness in the heart of the economy at the same time as other figures cast doubt over the strength of domestic demand. All of which is set against a backdrop of falling property prices – property investment makes up a significant chunk of GDP.

Beijing is saying that this latest move to boost growth doesn’t signal a change of policy, but it’s defiantly a more aggressive stance than we have seen recently from policy makers. In recent months the PBoC has been using targeted stimulus measures in an attempt to promote economic activity, whereas Friday’s move will theoretically have more of a wide-reaching impact and signals that Beijing has lost some faith in the ability of targeted stimulus to spur economic growth. However, we are unsure that even the use of Beijing’s big guns will have much of a prolonged impact in this instance on the real economy.

These moves will have a mixed impact on lenders

Along with the aforementioned rate cuts, the PBoC also increased the amount by which individual banks can set their own deposit rates above the benchmark. Banks can now set their own rate 20% higher than the ‘official’ rate as opposed to the prior 10% limit. This move will encourage competition between banks for funding as part of the PBoC’s overall goal of achieving full deregulation of deposit rates. Yet, it will also squeeze profit margins, putting pressure on lenders.

Does this signal that the PBoC is more comfortable with using its big guns?

The big takeaway from the PBoC’s decision to cut interest rates is that the bank is more comfortable using bold policy tools to support the economy than the market thought it was. Given the threats to growth, the fear that headline GDP may dip below 7% (currently 7.3%) and the PBoC’s apparent willingness to pull out its big guns, we believe we may see the bank cut interest rates again. In saying that, this outlook is largely data dependant. In the absence of any major shocks to the economy, Beijing may attempt to use targeted stimulus once again in order to avoid any adverse side effects further down the road that can accompany the use of bigger policy weapons.

What does this mean for the Australian dollar?

The impact that this may have on the AUD is even less certain. The Australian dollar has a very interesting, albeit mildly inconsistent, relationship with Chinese economic data. As we have just explained, the AUD typically reacts positively to stimulus announcements, but the currency’s reaction to Chinese economic data is less certain. Sometimes the aussie reacts positively to weak Chinese economic data as it increases the likelihood of stimulus injections from Beijing, while other times it can fall due to the apparent negative implications for China’s growth outlook. The former scenario is truer when Beijing isn’t already attempting to spur economic growth and the market wasn’t previously expecting any further easing. This is in contrast to weak economic data that threatens China’s growth outlook but the market doesn’t believe will have material impact on monetary policy, which typically pushes the aussie lower.

Technical look: AUDUSD

The rally on the back the PBoC’s announcement breathed some more life in AUDUSD, with pair initially shooting around 100 pips higher. Since then AUDUSD has retraced some of these gains but it managed to find some support around 0.8660. The big test for the pair in the near-term will be whether it can break above 0.8700.

Source: FOREX.com