Why the Chinese central bank timed its monetary policy shot for May

Lian Ping says tariffs could have shaved a percentage point off GDP growth

In this briefing:

• On 7 May, the Chinese central bank cuts interest rates for the first time in 2025.

• At the end of last year, Beijing signalled loosening of monetary policy to levels last seen in the aftermath of the GFC.

• Li Gengnan (李庚南) says the central bank was waiting to properly time any monetary policy adjustments, due to uncertainty surrounding the Trump administration's decisions.

• Lian Ping (连平) says Trump's tariffs could have major adverse impacts on China's economy, reducing GDP growth by up to a percentage point.

• Li Gengnan says a slew of other factors are supportive a rate cut, including deflationary pressure, tight liquidity, improving bank profitability and the need for the Fed to cut rates to bring the US economy "back from the brink."

• Lian Ping expects further loosening from the Chinese central bank in the second half of the year.

Chinese central bank debuts rate cuts in May

On 7 May, central bank governor Pan Gongsheng (潘功胜) unveiled a broad array of monetary policy measures to support China's economy in the wake of Trump's 2 April tariff hikes.

Chief amongst them were

• A 0.1 percentage point cut to China's seven-day reverse repo rate - considered the central bank's key short-term policy rate.

• A 0.5 percentage point cut to the required reserve ratio (RRR), which is expected to unleash 1 trillion yuan in long-term liquidity.

The move from the central bank was long anticipated within China, after Beijing outlined plans for vigorous fiscal and monetary policy measures in 2025 at the end of last year.

Beijing signalled biggest monetary easing since GFC

At the Central Economic Work Conference held in December, top policymakers said 2025 would see China implement "moderately loose monetary policy."

This marked the first time the phrase had been deployed by Beijing since the aftermath of the Global Financial Crisis over a decade prior.

The first quarter of 2025 came and went without any adjustments to the central bank's short-term policy rate, however. Nor were any adjustments made in April, after Trumps’ Liberation Day tariffs.

As a consequence, the one-year benchmark Loan Prime Rate (LPR) has also been static, holding steady at 3.1% since October last year.

Despite the strong rhetoric unveiled in December, one of China's top banking officials says a key focus of the central bank has been the careful timing of any adjustments to monetary policy, giving uncertainty surrounding the Trump administration's decisions.

Li Gengnan (李庚南), a banking regulator who previously held positions at the central bank and the Industrial and Commercial Bank of China (ICBC), says the notion of correct timing has been a key component of central bank boilerplate since the start of the year.

"The phrase 'opportune timing of RRR and interest rate cuts' (择机降准降息) has become the consistent stance of the central bank," Li wrote in an opinion piece published on 14 May (李庚南：央行为什么选择这个时点降准降息?).

Beijing wanted to first see the full extent of Trump's trade measures, as well as assess their likely impact on the Chinese economy, before taking action on the monetary policy front.

Central bank's rate cuts viewed as "extremely timely"

Lian Ping (连平), director at the China Chief Economist Forum, argues the central bank made good on its official commitment, and that the arrival of rate cuts just a month after Trump's Liberation Day tariffs was "extremely timely."

He highlighted the need to offset the negative impact of US tariffs on China's exports and GDP growth, which could prove considerable despite the extensive preparations made by policymakers in Beijing since the first round of the trade war in 2018.

"China's foreign trade could be hit with a major shock as a result of the US commencing tariff hikes against China at the start of April," Lian wrote on 7 May - the same date that the central bank announced its monetary policy measures (连平：适度宽松货币政策进一步发力，后续还有哪些政策空间?)

"Financial market volatility will also increase."

Lian sees US tariffs having a detrimental impact on the Chinese economy extending well beyond the export sector.

This is because any drop in Chinese exports will also affect domestic consumption and investment, if businesses targeting overseas markets start to retrench workers or dial back spending.

"According to preliminary estimates, for every 10% in US tariffs, China's exports could fall by 2%-2.5%," Lian wrote.

"If the US tariffs are not reduced, China's exports could decline by 8%-10% in 2025, and export growth could further decline by around 15% in 2026.

"As exports are blocked, there will also be a chain reaction in the areas of consumption and investment.

"If there is no intervention in the changes to exports, consumption and investment, we can't rule out China's GDP growth rate declining by around one percentage point in 2025 under extreme circumstances."

China's financial conditions supportive of rate cuts

Li Gengnan highlights a slew of other conditions in the Chinese economy that made the start of May the "best time" for the long-awaited rate cut from the central bank.

Deflationary pressure and weak demand

Despite China's Q1 GDP posting 5.4% YoY growth, Li says the economy is still vulnerable to weak consumer demand.

"As external shocks expand, inadequate domestic demand is still the biggest challenge facing China's economic development," Li wrote.

Total sales of retail consumer goods grew 4.6% YoY in April - beneath what Li says is the 5% threshold dividing strong and poor performance.

Real estate investment saw ongoing declines narrow, but still came in at -9.9% in YoY terms.

Li also points to unresolved deflationary pressure as an issue for the Chinese economy

In April, China's PMI index came in at 49.0, for a decline of 1.5 compared to the previous month. He says there is a strong chance that PMI remains in contractionary territory in May.

China's CPI has also been down -0.1 points in YoY terms for two consecutive months.

"All these high-frequency indices indicated a doubling up of weakness, and hinted that the bowstring of RRR and interest rate cuts had been drawn," Li wrote.

Liquidity on China’s financial markets tight

China's short-term policy rate - the seven-day reverse repo rate, has been at the low level of 1.5% since Q4 2024, with the central bank seeking to provide an accommodating liquidity environment.

Li notes, however, that a key measure of liquidity - the DR007 rate - which is the weighted average interest rate for seven-day repos on China's interbank market, has continually held high.