Why is China easing monetary policy?

The world’s central banks are starting to talk about pumping a little less money into their economies. All except one: the People’s Bank of China is now loosening monetary policy again. John Stepek explains why.

Central banks around the world have been pumping lots of money into their economies to keep them afloat during lockdowns.

Now that we are (hopefully) edging closer to the end of lockdowns, central banks have been murmuring about not printing as much money.

Or at least, that’s what most central banks have been saying.

But one rather important one has just loosened monetary policy yet further – the People’s Bank of China.

China’s economic recovery is bumpy rather than faltering

At the end of last week, the Chinese government – via the People’s Bank of China, the central bank – made it easier for banks to lend more money, by reducing the amount they need to hold in reserve.

To use the technical terminology, the Chinese central bank cut the reserve requirement ratio (RRR) for banks by 50 basis points (or 0.5 of a percentage point), starting from 15 July. In all that should enable banks to release another $150bn into the economy.

This rather stands out in a world where the rest of the major central banks are at least thinking about tightening monetary policy, not loosening it further. It’s also a little unnerving given that we’re meant to be having a rampant post-pandemic recovery.

If the world’s second-biggest economy is already needing to loosen monetary policy again, what does that mean?

Let’s try to unpack this and see if it’s anything we need to worry about.

Firstly, we need to remember that China went into this pandemic first and thus came out of it first too (notably before vaccines were developed, which is something we seem to be forgetting as we discuss our own release from lockdown).

So China has had a V-shaped recovery spurt. Now the recovery is slowing, and more quickly than many analysts had expected. This could at least partly explain the recent dip in commodity prices.

However, before we go too wild in terms of extrapolating this to all the other “V-shaped” recoveries across the world, it’s also worth remembering that China’s “first in, first out” status is a double-edged sword in a global economy.

It’s like trying to organise a party when all of your friends are stuck quarantining. Things might be fine in your house but your party isn’t exactly going to be raging when no one else can come.

Also, as Eoin Treacy points out on FullerTreacyMoney.com, a slowdown might also just reflect a drop in “demand for products associated with lockdowns” as other countries start to emerge from the pandemic.

The other thing about V-shapes is that they represent short, sharp rebounds. Once the rebound bit is done, the V-trajectory starts to turn into something else. That doesn’t mean it’s all over.

So it’s easy to read too much into these things, and as far as the global economy goes, I think there are just too many variables influencing the data. It’ll take a while before we see how this all turns out, and in the meantime, I still believe that logic suggests an overall arc pointing in the direction of longer-term strong recovery (with a lot of bumps along the way).

Yes, but why is China making lending easier?

So why is China cutting the RRR? As Julian Evans-Pritchard of Capital Economics points out, this is not necessarily a broad-based loosening of monetary conditions. “It is partly intended to offset tightening elsewhere”.

It’s more about shuffling the focus towards the more fragile parts of the Chinese economy and financial structure, “including the balance sheet weakness of highly-indebted firms”. In effect, it’s aimed at encouraging banks to cut borrowing costs for companies that might otherwise run into trouble.

As you’ve probably noticed, commodity prices have been spiking, or at least they were in the earlier part of the year. That’s put companies under pressure in terms of rising costs. So one argument is that, as Morgan Lau of Fidelity International tells Bloomberg, “the primary motivation for China is to support small and medium companies influenced by the spike in inflation”.

Meanwhile, China is trying to mature its financial system and make it more resilient and deeper. That involves making the system a bit more capitalist (ironically enough). This is why increasing numbers of companies have been allowed to go bankrupt.

If China wants to compete with the US on the economic and financial markets stage, it doesn’t have much choice other than to keep doing this. As Diana Choyleva of Enodo Economics describes it, China needs to “professionalise its capital markets”. But it also wants to maintain control over everything.

More than anything else, that means no sudden moves (notwithstanding the attempts to bring Didi to heel after it decided to list in the US in the face of opposition in China).

So overall, this looks like a move designed to ease potential strains in the system rather than evidence of something more serious (as yet). But it’s worth keeping an eye on. In any case, markets liked the move - they tend to like any sign that authorities might want lower rates.

And perhaps that’s the main thing to take from this right now. Markets seem nervous about growth or the recovery faltering. But China has just shown us what the response will be if it does: immediately reach for the rates lever. And until inflation makes it genuinely politically painful to do that, that’ll be the solution reached by central banks across the globe.

Anyway – if you’re in the mood for some thought-provoking big picture analysis on what you should really be worried about when it comes to China, listen to our latest podcast, where Merryn talks to historian Niall Ferguson about China, Taiwan and the US, among other topics.

Recommended

April price hikes - these are the bills going up in April
Personal finance

April price hikes - these are the bills going up in April

Households will be hit with a series of bill increases from April - here’s what they are and how you can save money.
31 Mar 2023
Where will house prices go in 2023?
House prices

Where will house prices go in 2023?

We explore what could happen to house prices in 2023 as the market continues to slow down.
31 Mar 2023
Investors flock to NS&I savings after SVB scare
Savings

Investors flock to NS&I savings after SVB scare

Investors are increasingly pumping their cash into the safety-net of NS&I - lured by increased rates and the security of a government-backed savings a…
31 Mar 2023
Nationwide: UK house prices decline at the fastest pace since 2009
House prices

Nationwide: UK house prices decline at the fastest pace since 2009

UK house prices fell for the seventh month in a row in March, Nationwide’s house price index showed.
31 Mar 2023

Most Popular

Will energy prices go down in 2023?
Personal finance

Will energy prices go down in 2023?

Ofgem’s price cap is now predicted to fall to around £2,000, based on average typical use, for the first time since 2022. We have all the details.
31 Mar 2023
Best areas for buy-to-let in the UK
Buy to let

Best areas for buy-to-let in the UK

If you’re thinking of getting a buy-to-let property you’ll want to know the areas in the country with the highest rental yields
29 Mar 2023
The best one-year fixed savings accounts - March 2023
Savings

The best one-year fixed savings accounts - March 2023

Earn over 4% on one-year fixed savings accounts.
30 Mar 2023