PBoC cut both rates and RRR again

Following a stock market sell-off and increasing fear of a looming financial crisis, the PBoC announced a symmetric 25bp benchmark rate cut on Tuesday, combined with a 50bp RRR cut. This is the second such combined cut, after a similar move on 27 June. Moreover, the PBoC removed the deposit rate ceiling for time deposits of 1y+, another step towards full interest rate liberalisation. 

"The latest easing matches our baseline interest rate and RRR forecasts and is consistent with our weaker-than-consensus USDCNY forecast of 6.8 by year-end. We are now adding one more benchmark rate cut of 25bp in Q4, due to weaker-than-previously-expected Q3 growth, and look for two more 50bp RRR cuts in Q4 2015, given our expectations of persistent capital outflows. We expect today's move to help support sentiment and economic growth in Q4, though the risks to our forecasts of 6.8% in 2015 and 6.6% in 2016 will remain to the downside", says Barclays.

The move comes after some rapid deterioration in the Q3 data and equity market turmoil. Following across-the-board weakness in the July activity data, including decelerating industrial production and moderating investment growth amid further slowing in property investment, the August Caixin flash PMI (released last Friday) fell unexpectedly to 47.1, its lowest level since March 2009. This suggests that the August data will be weaker than in July and Q3 growth will be lower than in Q2. While the official GDP growth was 7% in Q2, alternative indicators (LKQ index, electricity output, crude steel usage, and fiscal revenue) suggest actual growth of 50-200bp lower than the official print, depending on the sector. Meanwhile, the onshore stock market plunged for a fourth straight day, with the SHCOMP down more than 15% in two days and 42% from its June peak. The latest China data and stock market routs triggered a further dramatic sell-off in the global equity, currency and commodity markets, which had been under pressure since the surprise CNY devaluation on 11 August.

Today's bigger-than-expected monetary easing supports the out-of-consensus USDCNY forecast. Ahead of the IMF's SDR review, the PBoC made a commitment to liberalising the pricing mechanism of the USDCNY fixing rate to be more driven by the market. The CNY is overvalued vs the USD at the current level, hence greater market determination means currency depreciation. Given the expectation of slowing relative growth in China (with downside risks) and domestic households' increasing preference to diversify towards USD assets, a freer flow of capital is expected to be skewed towards currency outflows, more than offsetting the current account surplus and putting downward pressure on the CNY. The latest deposit and FX transaction data already point to accelerating capital outflows in July, reflecting concerns about the volatile equity market and softening economy. Looking ahead, capital outflows is expected to persist in H2.