Earlier this week, the PBOC made a “surprise” announcement cutting the reserve requirement ratio (RRR) for banks. The “surprise” is in quotes, because even though it wasn’t pre-announced, the economic situation was such that a lot of analysts were speculating that it was just a matter of time. The economic situation in China has been moving in such a way that a move like that was necessary.
The yuan has been moving higher, getting close to hitting the 7.0 handle, which hasn’t been seen since the middle of 2020. The action by the PBOC could be expected to weaken the currency, potentially leading the exchange rate above that key level. That has potential implications for quite a few other currencies in the region.
Why it matters
The RRR is the PBOC’s main policy tool. Essentially, it regulates how much money banks can loan out by varying the level of currency they must keep in reserve. Because banks create money on debt, this has multiplying effects on the amount of money in circulation. A cut in the rate implies more inflationary pressure; and an increase implies further monetary tightening.
Which is why there is increased attention on the data expected tomorrow. China July inflation rate is expected to come in at an annual 2.8% compared to 2.7% prior. But it comes on the basis of a deceleration in the monthly rate to 0.2% from 0.5% prior. Meanwhile, producer prices are expected to slow down to 3.1% from 4.2% prior.
The broader effects
China’s economy has been under pressure due to rolling lockdowns. Just this morning, the second largest city, Chengdu, announced that it would extend lockdowns as the number of covid cases increased. With inflation creeping up and the economy facing challenges, the PBOC has to decide whether it’s going to prioritize supporting the economy or keeping inflation under wraps.
The latest moves of the PBOC suggest the former. Last month, they lowered the Loan Prime Rate (the other primary policy tool), and last week the China Economic Daily called for another cut. This would make it easier for borrowers to get credit, potentially supporting the economy. But, also increasing the monetary base.
What it means for commodity currencies
With lower interest rates and rising inflation, naturally the yuan has been weakening. This might help improve the situation for exports, assuming that factories can produce in light of the lockdowns. But it also makes it harder for Chinese firms to import raw materials, because of higher cost.
Part of this problem can be mitigated by buying in yuan, such as energy from Russia as was recently agreed. But it might mean that there will be less demand for Australian and New Zealand exports. On the other hand, the increased capital expenditure could help Japanese machinery exports.