MNI: Low Credit Demand Feeds PBOC Easing Caution; Tariffs Key

The People’s Bank of China would be likely to further ease monetary policy should U.S. tariffs hit the country’s financial markets, but its scope for cutting interest rates will be constrained by concerns about banks’ deteriorating net-interest-margin and weak loan demand, advisors and former officials told MNI.

While deflationary pressure could also drive more easing later in the year, the PBOC is already beginning to worry that the country may be nearing a liquidity trap, in which monetary policy loses effectiveness at very low levels of interest rates, they said.

A rate cut in response to tariffs might send a positive signal to markets, but it would be unlikely to much impact on the real economy due to weak credit demand, noted a former PBOC official, adding that excess liquidity could simply fuel financial system arbitrage. 

While investors have expected monetary easing since Beijing adjusted the PBOC’s policy stance to “moderately loose” last September, the Bank has instead emphasised a more targeted approach.

“The central bank may wait to assess whether the economic recovery is sustainable,” the former official said, pointing to mixed economic signals from the first two months of the year.

A current advisor to the PBOC said the timing of policy adjustments will depend on both domestic and external factors, particularly the impact of U.S. tariffs set for April 2 and China’s Q1 GDP data, which will be released on April 16. The central bank aims to lift inflation closer to its 2% target, an objective which it views as tied to capital market performance, but annual CPI is only projected at around 1%, the advisor added. (See MNI INTERVIEW: Low Inflation Gives Room For More China Easing)

INTEREST MARGIN PRESSURES

But lower rates may complicate matters for banks. The largest state-owned lenders saw further revenue declines in 2024, with Industrial and Commercial Bank of China and China Construction Bank reporting shrinking profits for a third straight year, largely due to narrowing net-interest margins, 

Lower loan prime rates, reduced mortgage rates, and fierce competition are all cutting into asset yields, Bank of Communications Vice President Zhou Wanfu told a recent briefing.

A former PBOC monetary policy committee member said the central bank fears that lower rates could rapidly push down bond yields and destabilise the banking sector.

“Once a liquidity trap sets in, the entire financial system risks falling into panic,” he warned, adding that fiscal policy would be more effective in stimulating demand should the economic performance worsen.

At the same time, the weak performance of key indicators, such as M1, CPI, PPI and loan demand, make rate cuts inevitable, he added, predicting that banks will have to be allowed to reduce interest on deposits to compensate for lower lending rates.  

Shifts in U.S. Federal Reserve policy could also disrupt the PBOC’s easing cycle, though the impact should be limited due to China’s strict controls on the yuan exchange rate and capital flows, added the former MPC member. (See MNI: PBOC Persists With Yuan Support For Now-Advisors)

POLICY COORDINATION

Officials and advisors agreed that stronger coordination between fiscal and monetary policy will be essential to improve the efficiency of monetary easing.

But the former MPC member said that more issuance of shorter-term bonds and bills would better allow both the central bank and financial institutions to purchase government debt. China should adopt a short-term and high-frequency government bond issuance system similar to that used in the U.S., with monthly maturities and open-ended daily sales, he said, adding that this would help establish market-driven benchmark rates that better reflect actual demand for funds.

An economist serving as an advisor stressed that long-term economic stability requires stronger consumption and investment, and that liquidity injections alone would only fuel financial speculation rather than real growth. Sustainable solutions lie in reform to redistribute income and in technological innovation, reducing reliance on monetary stimulus, the economist said.