How China's Surprise RRR Cut Could Affect Forex Trends

China sure knows a thing or two about sneaking up on the markets! While forex traders were still out enjoying the weekend, the People’s Bank of China (PBoC) decided to reduce its reserve ratio requirement (RRR) by 1% – its largest cut since the dark days of the financial recession in 2008. Is this a sign that their economy is in big trouble?

china rrr stimulusIf this is the first time you’ve heard of the RRR, then lemme tell you that this simply refers to the level of cash that commercial banks are required to leave in the central bank’s vault. By lowering their RRR, the PBoC encourages banks to use more cash for their lending operations, eventually pumping more liquidity into the economy in hopes of boosting growth.

In Harry Potter’s world, this is just like having the goblins from Gringotts opening up the vaults and makin’ it rain Galleons in Hogwarts. You can imagine how students will spend more in Hogsmeade then!

Judging by China’s latest set of data, there seems to be no denying that the economy could use a little bit of stimulus. While the quarterly GDP came in line with expectations and managed to meet the government target, industrial production and retail sales reports have printed dismal readings, hinting at further economic weakness down the line.

However, Chinese central bank officials seem inclined to assure market watchers that all is well. In fact, policymakers claimed that the RRR cut was made to stabilize the volatile Chinese stock market. Prior to the PBoC announcement, Chinese equities plunged sharply following the decision by China Securities Regulatory Commission (CSRC) to tighten margin trading rules. Oh, come on…

The PBoC’s previous easing efforts, namely their two interest rate cuts since November last year and the RRR reduction in February, suggest that policymakers are scrambling to shore up their economy. A report on the Wall Street Journal even indicated that PBoC officials are considering long-term refinancing operations, a monetary policy easing strategy being used by the likes of the ECB, in order to stimulate lending and spending.

Is this really the ‘new normal’ for China? After enjoying double-digit growth during its glory days a few years ago, Asia’s superpower is now taking a page out of the feeble euro zone economy’s handbook!

Now this also has significant implications for global growth, as a prolonged slowdown in the world’s second largest economy could wind up dragging everybody down. This could keep investors very cautious with their money, lending more support for the safe-havens and lower-yielding assets. In addition, weak growth in China usually translates to lower demand for raw materials and commodity exports from Australia, its number one trade buddy.

But before y’all start hitting the panic button, keep in mind that the PBoC’s recent stimulus efforts have yet to kick in and that their latest RRR cut from 19.5% to 18.5% might be enough to keep their economy afloat. After all, their latest easing moves have been aimed at driving borrowing costs lower for small businesses, which account for a huge chunk of production and consumption.