Macroscope | China’s central bank eases into 2020 with a firm grip on loose liquidity

While policy easing remains – with falling lending rates and a cut to the reserve requirement ratio – investors should not expect a flood of liquidity. The 2020 prognosis? Loose but prudent monetary policy

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Investors should not expect the People’s Bank of China to introduce broad easing or massive monetary stimulus. Photo: Reuters

Published: 12:00pm, 3 Jan 2020Updated: 10:30pm, 3 Jan 2020

Heading into the new year, I have been thinking a lot about monetary policy. The amount of liquidity provided to markets in recent years has supported higher equity valuations and kept yields low (and thus, fixed-income prices elevated). The direction that central bank policies take in 2020 is an essential consideration when making investment decisions.

All signs point to the United States Federal Reserve continuing to keep interest rates steady, with greater monetary easing from the European Central Bank and Bank of Japan. That leaves the People’s Bank of China as the only major central bank without a clearly telegraphed policy plan for 2020 for now.

It is important to note that the PBOC’s policy stance has always been clear – the techniques for executing this stance is where questions remain. Chinese authorities have consistently told markets that their policy stance is prudent with a structural easing bias. In effect, China’s central bank has been saying it will support the economy with policy easing when needed, but investors should not get carried away in expecting broad easing or massive monetary stimulus.

How the PBOC translates this stance into specific policy actions is a question I often asked myself in the later part of 2019. This last week has provided some details.

Two major developments offer concrete guidance as to how the PBOC will go about conducting monetary policy in 2020: one, the effective abolition of one benchmark set lending rate; and two, a cut to the reserve requirement ratio.

China has been reforming its interest rate system since mid-2015. The authorities have been gradually steering financial institutions away from benchmark lending rates and towards pricing their loans off of more market-based measures of financing costs. Last August, the PBOC announced a new tool called the loan prime rate. This rate is set monthly based on a survey of the loans that banks make to their best clients.