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The People's Bank of China plans to cut interest rates this year as it makes a historic shift toward orthodox monetary policy to bring it closer to the US Federal Reserve and the European Central Bank.
In comments to the Financial Times, China's central bank said it would likely cut interest rates from the current level of 1.5 percent “in a timely manner” by 2025.
It added that it would prioritize “the role of interest rate adjustment” and move away from the “quantitative objective” of credit growth in what would be a reform of China's monetary policy.
Most central banks, such as the Fed, have only one variable, the interest rate, that they use to influence the demand for credit and activity in the economy.
I PBoC in contrast, it not only sets a range of different interest rates but also provides unofficial guidance to banks on how much they can extend their loan books.
While such guidance was its most important tool in managing the the economy For decades – as loans were directed to high-growth sectors such as manufacturing, technology and property – officials within the PBoC believe reform is now urgent.
“Rate revision is likely to be a real focus of the PBoC in 2025,” said Richard Xu, chief China analyst with Morgan Stanley in Hong Kong. “China's economic development must quickly change from a mindset that focuses only on expanding the market size (of banks' loan books).”
Credit requirement it has fallen due to the prolonged downturn in the property market. The PBoC also fears that credit growth targets lead to indiscriminate lending without consideration of risk, which is wasteful in the long run.
“In line with the needs of higher development, these quantitative targets have been decided in recent years,” the central bank said. “The PBoC will pay more attention to the role of interest rate management, and improve the establishment and transmission of market-oriented interest rates.”
As part of the change in management, the PBoC clarified last year that its main policy tool will be the seven-day reverse repo rate rather than the multiple interest rate it has relied on until now.
A reduced focus on credit growth targets could lead to overcapacity in China that has led to bad debts at home and disruptions in global industries such as steel.
But the central bank has struggled to implement its interest rate changes because the government wants to channel money into the high-tech and manufacturing sectors, which is easier under the old credit expansion system.
Even as it tries to make policy changes, the PBoC is also under pressure to fix China's economy.
During 2024, as part of an aggressive stimulus package since the Covid-19 pandemic, the central bank lowered the seven-day rate and the five-year rate that influences loan rates three times.
The moves came in the context of President Xi Jinping's pledge to achieve 5 percent economic growth despite problems in China's property sector and trade tensions with the US.
PBoC governor Pan Gongsheng and his predecessors Yi Gang and Zhou Xiaochuan have pushed for risk-based lending rates in recent meetings with officials from some of China's biggest banks, according to attendees.
Bankers at the meetings warned about possible confusion when the price of long-term loans since the market is familiar with the guidance from the PBoC, emphasizing the challenge of moving to a new system.
For international investors, if the PBoC succeeds, then China's monetary policy will begin to resemble the system they use in the US, Europe or Japan.
For the first time in two decades, the central bank also buy government bonds in the open market to inject money into the financial system in 2024, the same way the Fed conducts its policy.
Analysts say the PBoC still has the necessary ingredients for a policy based on interest rates, such as regularly scheduled, publicly disclosed meetings to make policy decisions.
Without such guidance, “market participants may find themselves guessing what will happen next”, said Haibin Zhu, China economist at JPMorgan Chase.