Record Rate Cut Shows Beijing Pursues Shock-and-Awe

By Ye Xie, Bloomberg markets live commentator and analyst

The record reduction in China’s key interest rate on Friday was a rare positive policy surprise from Beijing since the Omicron variant of Covid began to wreak havoc on the economy in the past two months.

It’s a clear policy U-turn that aims to offset some of the self-imposed constraints, such as housing restrictions, to boost business and household confidence. If so, more policy easing for the housing market and more fiscal spending are likely to come.

China’s banks lowered the five-year loan prime rate (LPR), which is tied to the mortgage rate, by a record 15 bps on Friday, triple the amount that economists had forecast. It was the second policy move in a week that was aimed at propping up the ailing property market, after the People’s Bank of China cut the floor of the mortgage rate a week earlier.

Until now, Beijing’s plan to save the economy had been conservative, focusing on liquidity injections and tax reductions. That had fallen short of what’s required to offset the destruction caused by Covid restrictions and the property slump. Take the housing sector: New home sales for the top 100 developers tumbled 59% in April from a year earlier. Goldman Sachs on Friday raised the default forecast for high-yield property developers’ bonds to 32% from 19%.

The efforts to lower mortgage rates show a clear sense of urgency to turn around the housing market. As Zhaopeng Xing, senior China strategist at ANZ Bank, said: “The cut signals that the leadership has ended discussion over the property sector and decided to rescue it as soon as possible.”

There are a few reasons to believe that the impact of the LPR cut alone will be limited. As Nomura’s Lu Ting pointed out, mortgage rates had already started to decline, even before recent policy moves. That did little to arrest the sales decline, in part because Covid restrictions limited mobility, jobs, income and confidence of residents. In addition, when consumer leverage is already high, the willingness and ability to borrow remains in question. In fact, property stocks fell Friday, even as the benchmark CSI 300 rallied.

What’s clear, then, is more policy follow-ups are likely needed to boost income, save jobs and lift confidence. Here’s is a laundry list from Citigroup on what Beijing could do to revive the housing and the broader economy:

• Ease restrictions on presale deposits, maybe even tinker with the “three red lines” on funding curbs to improve cash flow for developers
• Advance part of the 2023 special local-government bond quota to support investment
• Consumer subsidies or vouchers funded by the central government
• Special Treasuries to cover Covid expenses, as was done in 2020 (1 trillion yuan)
• General budget revision to expand stimulus as in 2016 (for tax reform), 2008 (Sichuan earthquake) and 1998 (Asian financial crisis)

Bloomberg Economics now forecasts China’s growth will trail the U.S. for the first time since 1976, when Chairman Mao died.  President Xi reportedly aims to avoid such a scenario in a year when he is expected to retain power for a third term.

The rate cut on Friday may be the beginning of a shock-and-awe attack to get ahead of sagging expectations.