WESTPAC: The brutal decline in China's stock market brought forward additional policy stimulus

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Was the decision by the People’s Bank of China (PBOC) to cut a key interest rate and selective reserve ratio requirements triggered by the steep decline seen in Chinese stocks in recent weeks?

It’s a question many have been asking themselves in recent days following the PBOC’s announcement late on Saturday evening.

According to Huw Mckay of Westpac, a highly-qualified voice in our opinion on anything to do with Chinese financial markets, the ructions in the nation’s stock market were highly influential on the both the decision and timing of the announcement to ease monetary policy further.

Here’s Mackay in his weekly “Phat Dragon” chronicle of the Chinese economy.

“Phat Dragon’s view is that the vulnerability of the equity market was a major motivation for cutting now and not waiting until the Q2 GDP and month of June data became available. On occasion, a policy action that precedes a quarterly data round can tell one a great deal about what the forthcoming data might look like. Phat Dragon feels that this is not one of those occasions. Q2 GDP is due for release on July 15, with June partial data out from the 9th. They may well justify further action. But why wait when you have ¥1.4 trillion in margin debt set against a wobbly equity market? In short, equities determined the timing of this move, but as the basic strategy has been well laid out, the PBoC was ready to deliver an internally consistent instalment of the plan at somewhat short notice”.

The chart below, from the RBA’s quarterly statement on monetary policy, shows the rapid increase in margin debt used to purchase mainland Chinese stocks.

In essence, while further policy easing was always likely to occur, the steep decline in Chinese stocks – something that has seen losses of around 20% ensue in just two weeks – brought forward the timing of cut to interest rates and reserve requirements.

Those who have been following financial markets over the past five years would be familiar with the term the Bernanke or ECB “put”, the notion that central banks will adopt easier monetary policy, or at least hint they will do so, in order to support financial markets.

Given what we’ve seen over the weekend, it looks like the PBOC “put” is now also in place.

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