China’s Move to Hold Mortgage-Linked Rate Seen as ‘Puzzling’

Chinese banks kept a key interest rate that guides mortgages on hold, a surprise move that sowed confusion over the country’s approach to stemming the nation’s property slump.

(Bloomberg) — Chinese banks kept a key interest rate that guides mortgages on hold, a surprise move that sowed confusion over the country’s approach to stemming the nation’s property slump. 

The five-year loan prime rate was unexpectedly held steady at 4.2% on Monday, according to data from the People’s Bank of China. Most economists had predicted the rate to be cut by 15 basis points following a similar reduction last week to an important central bank policy loan rate. That was seen as precursor for a cut to the 5-year LPR.

The one-year LPR was lowered by 10 basis points to 3.45% from 3.55%, a smaller cut than what most economists surveyed by Bloomberg had expected.

“The decision to keep the 5-year unchanged is puzzling,” said Zhang Zhiwei, chief economist at Pinpoint Asset Management Ltd. “It is not clear how to interpret this decision and the cut last week.”

Stocks in China and Hong Kong declined at the market open on Monday. The MSCI China Index slid as much as 1.1% to its lowest since June 1. The offshore yuan extended a modest decline against the dollar, weakening about 0.2%. China 10-year bond yields fell one basis point to 2.55%, the lowest since 2020.

The government has signaled more urgency in shoring up growth for the world’s second-largest economy as borrowing demand slumps, deflation pressures take hold and confidence struggles to recover. Days after last week’s shock cut to the PBOC’s medium-term lending facility rate, the central bank and financial regulators met with bank executives and told lenders again to boost loans.

That all culminated in expectations Monday that the loan prime rates would also be reduced. While the rates are determined by the banks, the PBOC has influence over the monthly setting. The rates are based on the interest rates that 18 banks offer their best customers, and they are quoted as a spread over the central bank’s one-year policy rate.

“The disappointing follow-through from the MLF cut to the LPR strengthens our view that the PBOC is unlikely to embrace the sizable declines needed to revive credit demand,” wrote economists at Capital Economics Ltd. including Julian Evans-Pritchard. “The upshot is that while monetary easing will provide some relief to indebted firms and households, it won’t be enough to put a floor beneath growth. Instead, the key will be the extent of fiscal support.”

Weak data recently has prompted prompting several banks to cut their growth forecasts for the year to below 5%, implying the government may miss a growth target set earlier this year. Investors are also concerned about contagion risks following a liquidity crisis at a major shadow bank. 

What Bloomberg Economics Says … 

“The surprise hold on China’s five-year loan prime rate conveys two messages. First, there may be doubts that slashing rates for new mortgage loans — which are already at a record low — is the best way to shore up the housing market. Second, it could be a signal that other — non-monetary — policy support is in the pipeline.”

— Eric Zhu, economist

Read the full report here.

Several analysts suggested that Chinese banks may have been limited in their ability to lower their prime rates even with last week’s policy rate cut, which was intended to reduce bank financing costs and encourage them to lend more. 

Chinese banks have experienced narrowing interest margins and lower profitability in recent years due to fiercer competition in the credit market and a decline in lending rates since the pandemic, the PBOC said in a special section of its quarterly report published last week. Banks need to maintain “reasonable profits and net interest margins” so they can serve the real economy and prevent financial risks, the PBOC said.

Lenders may have also been constrained because average new mortgage rates are at record lows. The average fell to 4.11% in June, according to last week’s PBOC report.

Last year, the five-year LPR was cut by a total of 35 basis points — more than the 20-basis point reductions seen in the MLF rate, and deeper than the 15 basis points worth of trims to the one-year LPR.

“The lack of ability to lower the LPR rate, which is determined by banks, even with such a strong MLF rate cut suggest more measures to lower banks’ cost of liabilities will become more urgent,” said Becky Liu, head of China macro strategy at Standard Chartered Plc. 

She suggested more actions may be forthcoming, including some combination of a cut to the reserve requirement ratio for banks, reduced deposit rates and trims to relending rates. 

Monday’s actions also send a signal “that authorities don’t want the property market to overheat,” said Bruce Pang, chief economist and head of research for greater China at Jones Lang LaSalle Inc.

“There has been speculation on whether the government will completely let loose property policies after the Politburo meeting omitted the pledge that housing is not for speculation,” he said, referring to a meeting held last month by the Communist Party’s top decision-making body. The absence of that slogan, a signature of President Xi Jinping, fueled speculation that some tough restrictions on property would be reversed.

“The signal now is that there will still be policy controls on the property sector, just that they will be optimized,” Pang said, adding that authorities have also introduced a mechanism for lowering new mortgage rates already, lessening the need to adjust the five-year LPR.

Policymakers may also have judged that cutting the mortgage reference rate “is not the most effective tool,” said Frances Cheung, rates strategist at Oversea-Chinese Banking Corp Ltd. 

“Either that’s it, or the regulators are mulling something more substantial in supporting the property sector,” she added.

–With assistance from Qizi Sun, Cormac Mullen, Tan Hwee Ann and Paul Dobson.

(Updates throughout.)

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