The takeaway from February is that the PBoC has undoubtedly switched to an easing bias. Last month the People’s Bank of China (PBoC) announced two surprise moves aimed at fighting increasingly large capital outflows and a general slowdown in the domestic economy. Given the deluge of soft economic data out of the world’s second largest economy over the last few months and a rapid deterioration of China’s all-important property market, it was only a matter of time before the PBoC did more to prevent a hard landing.
Early in the month the PBoC cut the reserve requirement ratio (RRR) by 50 basis points in an effort to meet liquidity needs for the Spring Festival. It’s not unusual for Beijing to pump liquidity into the market in the lead-up to Chinese New Year, but it typically uses open market operations as opposed to RRR cuts. The use of the RRR to pump liquidity into the financial system is a signal that Beijing is concerned about post-GFC record levels of capital outflows due to a weakening yuan and a softening property market. It also signals that the government is less concerned about this liquidity flowing largely into the stock market. Prior to this the PBoC had already injected around 855 billion yuan of liquidity into the market in December through the use of short-term liquidity operations, money which was less likely to flow directly into investments.
At the end of last month the PBoC decided to surprise the market again by cutting benchmark interest and deposit rates. The PBoC cut the benchmark one-year lending rate by 25bps to 5.35% and the one-year deposit rate by the same amount to 2.5%. This was the second time the bank elected to lower interest rates in only three months, which is another signal that Beijing is growing increasingly concerned about the health of the economy and the threat posed by persistent disinflation.
The deluge of disappointing data continued in February
The unease in Beijing is not surprising given consistently weak economic data coming from China lately (this has been a consistent theme in our monthly China roundups). This month the general theme of softer than expected economic data continued, almost across the board.
The data highlights:
• China’s monthly trade balance was pushed to a record $60.03bn by a dismal 19.9% y/y fall in imports (expected -3.2%). Lower import prices can partly explain January’s soft import numbers, but we still can’t excuse them. The slide in imports is the worst since Chinese factories were slashing inventories in response to the GFC. Also, exports fell for the first time since March 2014 (actual -3.3% y/y vs. expected 5.9% y/y) and they are the only thing propping up growth at the moment.
• Sentiment in China’s manufacturing sector is also deteriorating as economic activity shrinks. The official reading of Manufacturing PMI for January showed that pessimists outweighed optimists for the first time since September 2012; the Index remained in contraction territory in February at 49.9. This cynical view was supported in January by a slightly softer reading from HSBC’s private sector Manufacturing PMI (49.7), but the Index rebounded to 50.7 in February.
• Consumer prices rose a disappointing 0.8% y/y (expected 1.0% y/y), after rising 1.5% y/y in December. This is slowest pace of growth in five years and is further evidence that domestic demand is struggling. China’s PPI also came in below expectations as producer prices remain in deflationary territory for the 35th consecutive month.
The yuan’s reaction
As one would expect, increased concern about China’s economic vitality has hit the yuan, hard. USDCNY is now at its lowest level since October 2012. The PboC has been attempting to slow the flood out of CNY by setting a tighter reference rate than market conditions may dictate, but it has still allowed USDCNY to appreciate. As we have stated in the past, we expect the yuan to continue to weaken, both onshore (CNY) and offshore (CHY), in coming months and quarters, especially if the PBoC decides to loosen policy further, which we expect it will on the back of continuing disappointing economic data.