Desperate China cuts interest rates

The People's Bank of China cut 25bp in interest rates to re-ignite growth, lift falling inflation and cope with global weakness.

The rates cut was expected, said BBVA, and another one should be coming on the horizon given the dire situation in China's economic front.

"The move is in line with our expectations of up to two interest rate cuts in the coming quarters, in addition to further cuts in the RRR in view of recent weak economic indicators, falling inflation, and the deteriorating global environment. Nevertheless, the rate cut may take many market observers by surprise, especially those who had expected the PBoC to refrain from rate cuts in favour of further reductions in the RRR," said BBVA.

The rate cut is part of multi-pronged approach to ease the fall of China's growth, the research firm said, and could also suggest weaker-than-expected economic results.

"Importantly, greater rate flexibility has been introduced .The rate cut as the latest policy move by to support growth, along with various fiscal initiatives including recent subsidies to home appliance and auto purchases. We expect such policies to help ensure a soft landing, although there are downside risks to our previous 8.3% GDP growth projection for 2012," said BBVA.

"We will be watching closely for the next batch of monthly indicators for May due out this Saturday, June 9. The timing of today’s announcement could indicate that the authorities expect the data to be on the weak side. We expect another 25bp rate cut and 100 bp cuts in the RRR during Q2/Q3," it added.

The interest rate cut though could adversely narrow bank lending margins and profits.

"Although the lending and deposit benchmark rates were cut symmetrically, by 25bp each, to 3.25 percent and 6.31 percent respectively, changes in the discounts and premiums banks are allowed to offer imply a narrowing of lending margins. Specifically, banks can now offer a 20% discount from the benchmark lending rate (rather than 10% previously), and a 10% premium on the deposit rate cap (from zero previously)," said BBVA.

"The move is a step toward greater interest rate flexibility, and is in line with plans for gradual interest rate liberalization. The effective narrowing of lending margins also follows better-than-expected profit outturns in the banking industry for 2011, and is in line with our outlook for reduced profitability in the coming years," it added.