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China RRR cut lifts markets but weak PMI point to more pain ahead

China’s central bank surprised markets on Monday by cutting the reserve requirement ratio (RRR) for large banks by 50 bps to 17%. The move is the first monetary easing by the People’s Bank of China (PBOC) since October 2015 and the fifth cut to the RRR in the past year. The RRR is the proportion of cash that banks must hold as reserves and the latest reduction should boost liquidity in the economy by around $100 billion.

The cut, which is effective as of Tuesday, lifted market sentiment across Asia today, helping traders shrug off another set of weak manufacturing surveys for China and other Asian economies. It also allowed the PBOC to set a higher midpoint for the yuan at 6.5385 per dollar today, compared to Monday’s fix of 6.5452 per dollar. Interestingly, the yuan has steadily depreciated by around 0.8% against the dollar since mid-February. The PBOC has been intervening heavily in foreign exchange markets since last summer to support the Chinese currency, which has come under pressure from large capital outflows caused in part due to a slowing economy.

Analysts suspect that speculative pressure on the yuan is one of the reasons why the PBOC has refrained from cutting its main lending rate further since last October. Instead, the PBOC has opted in recent weeks to inject liquidity into the banking system through reverse-repurchase operations. However, following the G20 meeting last week that concluded without any coordinated action decision, China may be keen to be seen to be taking action to restore confidence in the economy.

China’s massive industrial sector has shown no sign of emerging out of the doldrums as manufacturing activity continues to shrink. Figures out today from China’s National Bureau of Statistics, showed February’s manufacturing PMI eased to 49.0 from 49.4 in January. The reading is below consensus estimates of 49.3. The non-manufacturing PMI also disappointed, decreasing to 52.7 in February from 53.5 the prior month, signalling weaker overall demand in the economy. A figure above 50 represents expanding activity and below 50 indicates declining activity.

Meanwhile, the alternate manufacturing PMI from Caixin fell to a 5-month low in February, dropping to 48.0 from 48.4 previously and falling short of expectations of 48.3. Companies in the survey reported lower new business orders for the eighth month in a row. Export orders fell for a third straight month, while staff levels declined at the fastest pace since 2009.

On Monday, China’s government announced plans to reduce the workforce in state-owned coal and steel companies by 1.8 million as authorities move ahead with their aim of streamlining ‘zombie’ corporations that have fallen victim to industrial overcapacity in the face of slowing demand. On the positive side, job losses from the current slowdown remain limited in comparison to the massive layoffs seen after the Asian financial crisis in 1998. The unemployment rate in China stood at 4.99% in January according to government survey data.

Most analysts expect the PBOC to cut both the RRR and its main lending rate further in the coming months, especially given that most of China’s main trading partners in Asia are now also facing a severe slowdown.

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