FT Alphaville " China's asymmetrical and anti-bank rate cut Everybody's talking about China's unexpected rate cut. But here's why this particular rate cut is a little bit different. It is, as Chinascope explains on Friday, asymmetrical: As they note: This year's second benchmark rate cut is asymmetrical, with deeper cut and lower floating range for lending rates, aimed at spurring lending. Loan growth, is in our estimation sufficient and therefore the interest rate cut runs the risk of accelerating inflation. Here, meanwhile, is SocGen's Wee-Khoon Chong on the matter: PBoC cut benchmark 1yr lending and deposit rate by 25bp and 31bp to 2.80% and 6.00% respectively ahead of the data releases next week. Well, we know what the data going to be like especially on inflation. Is this the last one? Possibly, but market would definitely looking for more. The magnitude of easing this time is more or less similar to the one delivered in early June. One marginal different is the 1yr lending is reduced by 6bp more in 1yr segment vs the rest of the curve (25bp cut). The rate cut in deposit follow the same move as in June, i.e. large cut in longer-tenor. For example, 25bp from 3mth to 1yr, 35bp in 2yr and 40bp in 3yr. See Table below. Furthering from the liberalisation of deposit rate in June (now allowed to float 10% (previously 0%)), PBoC also today adjust the lending margin by allowing loans to be up to 30% less than benchmark from 20% previously. The rate cut today is likely to rewiden the spread between 2y CNY NDIRS and 1yr benchmark deposit back to the low and therefore leading to steepening of CNY 2y-5y NDIRS curve. We would like to reiterate our call for a 2y-5y CNY NDIRS steepener with a first target of 60bp, to hit its 2009 high of 100bp in the coming months. Which means that lending rates now look like this (click to enlarge): Thus, the difference between the official corridor and the actual real world corridor is potentially narrowed. According to Nomura on Friday, this is likely to squeeze bank interest rate margins and hurt banks" profitability - an that, really, is what's surprising about Thursday's move: Allowing banks to set the lending rate at 70% below (previously the limit was 80% below) the benchmark lending rate was a major surprise. This is further interest rate deregulation (last month, the lending rate floor was lowered from 90% to 80%, and the deposit rate ceiling was raised to 10% above the benchmark rate) and a positive sign that, despite the political transition of leadership, Beijing is continuing with much needed financial reforms. Interest rate deregulation is important to encourage banks to become more commercial in order to properly price risk, and it suggests that capital account liberalization and bond market deepening will continue as all these reforms need to occur in tandem. Indeed, Chinese banks were underperforming on Friday due to concerns related to margin contraction. But given that loan demand is weak, we presume the PBoC feels the extra flexibility to offer loans at up to a 30 per cent discount below the official rate is needed to pull in demand. As Bloomberg notes: Industrial & Commercial Bank of China Ltd., the nation's largest, dropped 1.4 percent to HK$4.23 as of 12:00 p.m. break in Hong Kong, and lost 1 percent in Shanghai. China Construction Bank Corp. (939), the second biggest, fell 2.3 percent in Hong Kong and Bank of Communications Co., the fifth largest, declined 3.1 percent after losing as much as 4.6 percent. We should add that the moves come as the PBOC continues to inject liquidity via reverse repos (aka taking collateral in exchange for loans to banks). On July 3 it loaned as much as RMB143bn to the market. In short, the PBOC is firing on all cylinders. Related links: The China OMG moment - FT Alphaville The BoE and China hit together again - FT Alphaville This entry was posted by Izabella Kaminska on Friday, July 6th, 2012 at 10:04 and is filed under Capital markets. Tagged with Banks, china, chinese rates, PBOC.