China cuts interest rates in the face of what is projected as bad economic data

06/07/2012 5:24 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The People’s Bank of China cut interest rates today for the first time since 2008.

I think the move adds up to shock without much awe. The shock is that the cut in benchmark interest rates came earlier than expected. (Most observers, myself included, were thinking July.) But the cut to the benchmark one-year lending rate is just 0.25 percentage points (to 6.31% from 6.56%), so I wouldn’t call it “awe.”

The official one-year rate paid on deposits also took a cut today going to 3.25% from 3.5%. That cut would mean that savers are still losing ground to inflation, which dropped to a 3.4% annual rate in April.

But the People’s bank also gave Chinese banks new room to change what they pay on deposits and what they charge for loans. Banks will be able to offer a 20% discount on the official lending rate (that’s up from the previous 10% maximum discount) and, for the first time, to offer deposit rates to savers that are up to 10% higher than the official rate. Together these two changes introduce the opportunity for an unprecedented degree of competition in China loan and deposit market.

My suspicion is that the People’s Bank moved today because the economic data to be announced this weekend looked very, very weak. According to a survey of economists by Bloomberg, weekend data will show industrial output in China falling to annual 9.8% growth, which would be the lowest rate in three years.

This weekend’s data will also show, economists project, that inflation fell even further in May after a decline in April to 3.4%. The consensus projection among economists is that May inflation fell to 3.2%.

I’d like to see how the market reacts over the next few days to this mix of an early interest rate cut and data showing slower than expected growth. Investors could decide that news of slower growth outweighs the interest rate cut, leaving stocks to stumble. Or they could decide that the interest rate cut signals that China is getting even more aggressive on stimulating its economy. Economists project that the People’s Bank will cut one more time in 2012—and that might also encourage investors.

It’s good to remember right now, however, that stimulus, even the stimulus of an interest rate cut, takes a while to go into effect. You can see this kind of typical lag at work in the real estate market right now where the sales rate for residential housing in the 10 Chinese cities tracked by E-house China R&D Institute climbed to 6.7 million square meters in May. That’s the highest figure for 16 months. But land sales in these same cities fell by 31% in May from the May 2011 level as developers remained reluctant to buy more land until they see more evidence that the growth in housing sales is a sustained upward trend.

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