China has room for more policy easing, despite today's strong economic data

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Despite a raft of economic data beats earlier today, including economic growth holding steady at 7.0%, China’s central bank, the PBOC, looks set to continue on its path of aggressive monetary policy easing.

So say Li-Gang Liu and Louis Lam, China economists at ANZ, who believe subdued inflationary pressures and the recent stock market slump will ensure monetary policy conditions will have to become more supportive in the second half of the year.

Here’s Liu and Lam:

“As deflation risk remains elevated and market sentiment deteriorated sharply amid stock market slump, China’s monetary and fiscal policies will have to become more supportive in the remainder of year. Perhaps the best policy option in the near term is for the PBoC to cut RRR in July by at least 50bps. Such a policy action could achieve two short-term objectives: first, it will send a strong signal to the equity market that the liquidity in the banking system is plentiful; second, it will reduce money market rate and banks’ lending rates further, facilitating banks to lend to the real economy. As the PBoC has just announced that it will do whatever it can take to safeguard financial stability in China, we expect such a policy action could be as early as in July.

In addition, subdued CPI will also provide room for the PBoC to cut interest rates. We maintain our forecast that interest rates will be cut by another 25bps in Q3, while the RRR could be cut by 100 bps with 50bps each in Q3 and Q4.”

Here’s a chart from ANZ that reveals just how far CPI is undershooting government targets at present.

While an understandable call based on the inflation outlook, it is interesting to see just how far China’s stock market has come in influencing the PBOC’s monetary policy settings.

Only a year ago it would have been unheard of, now it’s the norm. It’s remarkable.

Having already cut interest rates four times and the reserve ratio three in the past year, now further monetary policy stimulus is potentially on the way to support the nation’s stock market – something that has risen more than 85% in just the past 12 months.

To some it may appear irrational, but given recent policy decisions to underpin Chinese stocks, it’s now deemed by many to be the norm.

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