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The People’s Bank of China plans to cut interest rates this year in a historic shift toward more orthodox monetary policy, bringing it in line with the U.S. Federal Reserve and the European Central Bank.
In comments to the Financial Times, the People’s Bank of China said it would likely lower interest rates from the current 1.5% level “at an appropriate time” in 2025.
It added that it would prioritize the “role of interest rate adjustment” and move away from the “quantitative goal” of increasing lending, which would amount to a shift in China’s monetary policy.
Most central banks, such as the Federal Reserve, use only one policy variable to influence credit demand and economic activity: the benchmark interest rate.
In contrast, the central bank not only sets a number of different interest rates, but also gives banks informal guidance on how much to extend their lending facilities.
These guidelines have been the most important tool in managing the economy for decades, as lending has been directed to high-growth sectors such as manufacturing, technology and real estate, but officials within the PBOC say reforms are needed. I think this is an urgent matter right now.
“Interest rate reform is likely to be a real focus for the central bank in 2025,” said Richard Hsu, chief China financial analyst at Morgan Stanley in Hong Kong. “China’s economic development requires an urgent shift from a mindset that focuses only on expanding the market size (of bank loan books).”
The prolonged downturn in the real estate market has caused credit demand to collapse. The central bank is also concerned that its credit expansion goals will lead to indiscriminate lending without considering risks, which will be wasteful in the long run.
“In line with the requirements of quality development, these quantitative targets have been phased out in recent years,” the central bank said. “The People’s Bank will pay more attention to the role of interest rate control and improve the formation and transmission of market-oriented interest rates.”
As part of the regime change, the central bank last year revealed that its main policy tool would be the seven-day reverse repo rate, rather than the numerous interest rates it had previously relied on.
Reducing the focus on credit expansion goals could curb China’s rampant overcapacity, which is contributing to domestic bad debts and disruption to global industries such as steel.
But the central bank has struggled to implement the shift to interest rates, which was easier under the old credit expansion system, as the government wants to direct money to the tech sector and manufacturing.
While the People’s Bank attempts to make structural changes to its policies, it is also under pressure to reflate China’s economy.
As part of the most aggressive economic stimulus package since the coronavirus pandemic, the central bank will raise the seven-day interest rate, which affects mortgage prices, twice in 2024 and the five-year interest rate. Interest rates were lowered three times.
The move comes against the backdrop of President Xi Jinping’s pledge to achieve 5% economic growth despite problems in China’s real estate sector and trade tensions with the United States.
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People’s Bank of China President Ban Gongsheng and his predecessors Yi Gang and Zhou Xiaochuan have pushed for risk-based loan pricing in recent meetings with officials from China’s biggest banks, according to attendees.
Banking officials at the meeting warned that there could be confusion in pricing long-term loans as the market is accustomed to the People’s Bank of China’s guidance, and cited the challenges of transitioning to the new system. emphasized.
For foreign investors, if the People’s Bank of China succeeds, China’s monetary policy will resemble the systems they are used to in the United States, Europe or Japan.
For the first time in 20 years, the central bank bought government bonds on the open market to inject money into the financial system in 2024 in a manner consistent with the Fed’s policy management.
Analysts said the central bank still lacked essential elements of an interest rate-based system, such as a regular public meeting schedule to make policy decisions.
Without such guidance, “market participants may be left speculating about what will happen next,” said Haibin Chu, China economist at JPMorgan Chase & Co.
