China’s central bank plans to change policy as pressure mounts on the economy

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The People’s Bank of China plans to cut interest rates this year as it makes a historic shift in monetary policy to bring it closer to the US Federal Reserve and the European Central Bank.

In comments to the Financial Times, China’s central bank said it may cut interest rates from the current level of 1.5 percent “in due course” in 2025.

It also said it would prioritize “the role of interest rate changes” and move away from “quantitative targets” for credit growth in what would amount to a change in China’s monetary policy.

Most central banks, such as the Fed, have only one policy, the interest rate, that they use to influence the demand for credit and activity in the economy.

The PBoC on the other hand it not only sets a wide range of interest rates but also provides unofficial guidance to banks on how much they should expand their loan books.

Although such guidance was its most important tool to control the economy for decades – as loans were directed to high-performing sectors such as manufacturing, technology and goods – officials inside the PBoC believe that change is now accelerating.

“Standard improvements may be the PBoC’s real target in 2025,” said Richard Xu, chief financial analyst for China with Morgan Stanley in Hong Kong. “China’s economic development needs to quickly move away from a focus solely on expanding the market size (of bank loan books).”

Credit requirement you are broke due to the prolonged downturn in the stock market. The PBoC also fears that debt growth targets lead to indiscriminate lending without consideration of risk, which is damaging in the long term.

“To adapt to the needs of quality improvement, many of these targets have been eliminated in recent years,” the central bank said. “The PBoC will pay more attention to the role of interest rate management, and improve the setting and transmission of market-oriented interest rates.”

As part of the regime change, the PBoC clarified last year that its main policy tool will be the seven-day reverse repo rate instead of the interest rate it has relied on until now. .

The reduced pressure on provisions for credit growth could also slow the spread of corruption in China that has caused bad debts at home and hampered global industries such as steel.

But the central bank is struggling to implement its reform on interest rates because the government wants to shift money to the high-tech and manufacturing sectors, which are easy under the old system of credit expansion.

Although it is trying to make a structural change in policy, the PBoC is also under pressure to revive China’s economy.

In 2024, as part of the strongest package since the Covid-19 pandemic, the central bank lowered the seven-day rate twice and the five-year rate that influences credit prices three times.

These measures came as a result of President Xi Jinping’s commitment to achieve economic growth of 5 percent despite the problems in the Chinese goods sector and trade disputes with the US.

PBoC Governor Pan Gongsheng and his predecessors Yi Gang and Zhou Xiaochuan stressed risk-based lending rates in recent meetings with officials from some of China’s biggest banks, according to attendees.

Banks at the meeting have warned of potential confusion when buying long-term debt since the market is accustomed to guidance from the PBoC, highlighting the challenge of moving to the new system.

For international funds, if the PBoC succeeds, then China’s monetary policy will begin to resemble the system they are used to in the US, Europe or Japan.

For the first time in twenty years, the central bank is also buy government bonds open market to inject money into the financial system by 2024, the same way the Fed conducts its policy.

Analysts said the PBoC still lacks key tools for a system based on interest rates, such as regularly scheduled, publicly disclosed meetings to make policy decisions.

Without such guidance, “market participants can find themselves guessing what will happen next”, said Haibin Zhu, China economist at JPMorgan Chase.