China cuts rates as global economic crisis deepens

08 Jun, 2012

China delivered a surprise interest rate cut on Thursday to combat faltering growth, underlining concern among policymakers world-wide that the euro area's deepening crisis is threatening the health of the global economy.
The country's first rate cut since the depths of the global financial crisis in 2008/09 came after the Federal Reserve's second-highest official made a case for more policy easing in the United States, and followed an emergency conference call on Tuesday by the financial leaders of the Group of Seven industrialised nations to discuss Europe's debt crisis.
It was followed shortly after by comments from Fed Chairman Ben Bernanke that the US central bank was prepared to take action to protect the financial system and US economy. "The Federal Reserve remains prepared to take action as needed to protect the US economy in the event that financial stresses escalate," Bernanke said in prepared testimony to the US Congress.
Marc Ostwald, a rate strategist at Monument Securities in London, said the China rate cut combined with Federal Reserve hints and hopes in markets that Europe will deal urgently with Spain's banking crisis would support risk assets. "It will be construed positively particularly in close alignment with what we've seen," he said. The Chinese cut and Bernanke's statement stood in contrast, however, to the decision by the European Central Bank on Wednesday to leave rates unchanged and hold off on more stimulus, placing the onus on fighting Europe's crisis on governments.
The People's Bank of China, the central bank, cut the official one-year borrowing rate by 25 basis points to 6.31 percent and the one-year deposit rate by a similar amount to 3.25 percent. The cuts confounded the call of many economists who thought the central bank would refrain from cutting policy rates this year even though policymakers had voiced the need to support growth.
"It's obviously a very strong signal that the government wants to boost the economy, given the current weakness, especially in demand," Qinwei Wang, economist at Capital Economics in London, told Reuters The European Union is China's single biggest foreign customer, and faltering demand there has led to worries about the knock-on effect to domestic consumption if industrial activity slows dramatically.
A sudden collapse in global trade in late 2008 saw an estimated 20 million Chinese jobs axed in a matter of months, prompting Beijing to roll-out a 4 trillion yuan ($635 billion) fiscal stimulus plan to bolster domestic economic activity. While the cut to borrowing costs should help in the near term to shore up an economy on course for its weakest full-year expansion since 1999, the central bank also gave banks more room to set competitive lending and deposit rates to further liberalise China's financial market.
The rate cut, announced after financial markets closed in Asia, helped shares elsewhere rally. World shares, measured by the MSCI world equity index rose to its highest level in more than a week. The euro rose. China last changed the borrowing rate in July 2011 when the 1-year benchmark lending rate was raised by 25 bps to 6.56 percent.
GOOD AND BAD Many world leaders, including in Europe, have been alarmed about the latest turbulence in the euro area debt saga as Spain is fast losing the confidence of financial markets, although it did successfully sell debt on Thursday. A Greek election this month could also push Athens closer to leaving the bloc. The problems of Spain's banks were underlined on Thursday when financial sector sources told Reuters an International Monetary Fund report on Spanish banks next week will show the country's troubled lenders need a cash injection of at least 40 billion euros ($50 billion).
"We must find ways to deal with this fairly quickly because (Spain) is today the major threat to the world economy," Swedish Finance Minister Anders Borg told Reuters. After the G7 call this week, Japan's Finance Minister Jun Azumi said the grouping shared the view that it should work to ease financial market worries ahead of a G20 meeting in Mexico later this month, where Europe is likely to top the agenda.

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