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China pulls the monetary lever further still

As expected, the People's Bank of China has pulled another monetary policy lever cutting its benchmark interest rates for the third time in six months.

CHINA ECONOMY
Source: Bloomberg

The one-year benchmark lending rate has been cut 25 basis points to 5.1% and the one-year benchmark deposit rate has been cut by the same amount to 2.25%. On top of this the deposit rate ceiling has been raised from 1.3 times to 1.5 times of the benchmark rate.

All this was widely expected by the market; the rumours coming out of the mainland was the private banks were gearing up for such an announcement as early as Sunday week ago. However, the one thing that may be evident in trade this week is that the scope and scale of the policy changed is a little weaker than analysts expected.

The reasoning for the cuts to interest rates are fairly self-explanatory I think - there three factors that may be the reasons behind the cuts and they are:

- Weak growth – first quarter activity was weak. Industrial production (IP) was a particular concern here with the March numbers at 5.6% year-on-year. This would be as concerning as the GDP slowdown for the PBoC and the central government. Now, we may see a bounce in the April IP figures on Wednesday, however, the fact the PBoC has pulled down the benchmark rate now suggests the bounce won’t be as strong as needed – adding to the risk around GDP and the need to act.

- Real lending rates are still comparably high – this is despite the fact the PBoC has cut the reserve requirement ratio and increased liquidity into the interbank market. The downstream rates at the retail end is still high on a real basis. The impact of which are being seen in the CPI reads should be seen again in the April CPI read.

- Inflation is weaker than forecasted currently and high interest rates are likely to be a major factor for the inflation read on financial strain. Reducing the financial burden on existing borrowers will release some of that strain. However don’t expect this to happen overnight as loan rebalances are not immediate. Loan adjustments are either monthly or quarterly and even yearly in some instances this will need time to filter out.

- Market heat no longer a major concern – The pull back in the China A50 last week should have eased concerns of overheating and stretched valuations. The cuts will positively impact the Chinese mainland markets, however, the upside is more likely to see the A50 returning to late-March levels (and slightly higher) rather than exploding further and becoming overly top-heavy. The dilemma is that strong equity markets that have low growth are very susceptible to a correction –an issue not just facing China but several other major economies.

On the open of our out-of-hours markets we have seen Hang Seng selling and mainland buying. The question now is will that continue into the cash market session?

Finally, and above all else the threat Premier Li Keqiang’s 7% GDP forecasts is still a major driving factor of policy in China and will remain so.

Ahead of Australian open

The China story should be a help to the ASX on the open today – since the intraday high of 5996 the market has lost 362 points or 6% (solid pull back) last week alone it fell 3% from the open to the close. However it lost as much as 5% on the intraweek high to low – that kind of volatility hasn’t been seen in two years and shows that the bulls were finally overrun after testing 6000 five times.

I would expect to see upside this morning on the back of the China news, further digestion of the Statement of Monetary policy from Friday that was dovish in nature and the fact iron ore and Brent moved up.

Based on Saturday’s close of the futures market we are calling the ASX up 21 points to 5655. Be aware NAB is still in a trading halt for its massive $5.5 billion raising and WBC is due to go ex-dividend on Wednesday - there is downside coming this week.

The other interesting Australian event coming this week is tomorrow’s budget. Most of which has already been leaked, so I don’t expect anything out of the ordinary to be market affective but an event to be aware of none the less.

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