China’s Benchmark Interest Rate Expected to Stay Firm after Holding Steady for Sixth Consecutive Month

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Domestic analysts expect China’s benchmark loan prime rate (LPR) to continue to hold firm, after the prints for February remained at the same level for the sixth consecutive month.

The latest LPRs announced by China’s National Interbank Funding Center on 20 February were 3.65% for the 1-year LPR and 4.3% for teh 5-year LPR, both of which remain unchanged from the reading in January.

Since the last reduction in August last year, China’s LPRs have remained unchanged for the past six months. Domestic observers said there is no room for a reduction in the LPRs, for a range of reasons including policy interest rates remaining unchanged, market interest rates rising, bank liability costs lifting, and the interest margins of lenders continuing to narrow.

Wen Bin (温彬), Chief Economist at China Minsheng Bank, said to state-owned media that the LPR continued to “stand still” in February because there is no basis or room for downward adjustment.

“Policy interest rates such those for the medium-term lending facility (MLF) remain unchanged and market interest rates are rising rapidly. This will increase the cost of bank liabilities, and with the superimposed impact of both assets and liabilities, the net interest margins of banks will come under further pressure.”

In February the MLF interest rate – which is the basis for LPR pricing, remained unchanged. On February 15, the People’s Bank of China (PBOC) engaged in 499 billion yuan in MLF operations at unchanged rates. 300 billion yuan in MLF expired in February, with analysts previously forecasting that the continuing increase in the outstanding MLF volume at unchanged rates would reduce the likelihood for LPR reduction this month.

At the same time, the recent rise in market interest rates has also put pressure on the liabilities side of bank balance sheets, while the quoting banks for the LPR do not have sufficient motivation to reduce their LPR quotes.

Wang Qing (王青), Chief Macro Analyst at Golden Credit Rating, said factors such as high loan growth and rising economic recovery expectations have recently driven a rapid rise in market interest rates for financial institutions.

“Since February, the short-term DR007 interest rate has hovered above the 7-day reverse repo rate most of the time, and the average yield to maturity of one-year interbank certificates of deposit for commercial banks (AAA grade) has also increased by 0.1 percentage points compared to the same period last month, which means a rising marginal cost of funds for banks.”

In addition to this, effort by China’s financial regulators to drive economic growth by reducing loan rates are beginning to take effect.

“The interest rate of first home loans in some areas is already lower than 4%, and it may not be the best time to lower the policy interest rate and guide the market interest rate to decline,” said Dong Ximiao, chief researcher at China Merchants Union Finance.

“The LPR remained unchanged in February, which may also take into account the fact that loan rates are already at a historically low level as well as external economic factors. With the United States still raising interest rates, keeping the LPR unchanged will help the RMB exchange rate to remain basically stable.”

Wen Bin said that since the start of the year Chinese banks have continued to drive corporate loan extension through “price cuts”. At the same time, in order to drive growth in consumer loans and business loans, the interest rates for these loans has also decreased compared with the second half of last year.

“It is expected that the loan interest rates will continue to decline in the first quarter. For high-quality enterprises, the loan interest rate obtained is expected to be significantly reduced on the basis of LPR.”

“It is unlikely that the financing costs of the real economy will rebound sharply in the short term,” Wang Qing said. “At present the economy has entered the recovery process, but the foundations for recovery are still not solid. In the short term, it is still necessary to keep corporate financing costs and personal consumption credit costs at a low levels to create a favoruable monetary and financial environment for economic recovery.”

According to Wang, the reason why PBOC has continued to undertake a volume of reverse repos since February has been to curb the rapid rise in market interest rates. He predicts that the financing costs for China’s real economy in the first half of this year will remain low, and it is unlikely that there will be a sharp rebound in short-term market interest rates.

Domestic observers nonetheless see the potential for a decline in the 5-year LPR in the near future, particularly given the tenuous health of China’s property market.

Wen Bin said that at present, all parties are paying close attention to the process of loosening credit and whether or not the property market can stabilize and stage a comeback in tandem with the broader recovery of the Chinese economy.

“With the increase in the willingness to undertake corporate financing and the rising activity of the real estate market, the necessity of cutting the reserve requirement ratio and interest rates in the short term will decrease,” Wen said.

“In order to avoid the failure of the traditional monetary policy transmission mechanism, the timing of subsequent RRR cuts and interest rate cuts needs to be better implemented.”

Wen Bin said that there is room for a further cut to the RRR of 0.5 percentage points this year, while the 5-year LPR could be slightly lowered by around 10 basis points.

Targeted policies, including targeted interest rate cuts, are expected to be the keynote for Chinese financial regulators in 2023.