China's Central Bank Cut Interest Rates Today for the First Time Since 2012

11/21/2014 5:45 pm EST

Focus: GLOBAL

Jim Jubak

Founder and Editor, JubakPicks.com

Supplying more money into the banking system has largely failed to stimulate the Chinese economy, so the People's Bank of China is going back to the demand side, and, as MoneyShow's Jim Jubak points out, financial markets have applauded the policy shift.

If the supply side doesn't work, try the demand side.

After a year and a half of trying—and largely failing—to stimulate China's economy by supplying more funds to the country's banking system, today the People's Bank of China went back to its demand side tools and cut the benchmark one-year deposit rate and the one-year lending rate for the first time since July 2012.

Supplying more money to the banking system had failed to increase bank lending. Now the hope is that cutting interest rates will increase demand for loans, since those loans will be cheaper to potential borrowers.

Financial markets have applauded the shift in policy. The Shanghai Composite gained 1.39% on the session.

China's central bank lowered its one-year lending rate by 0.4 percentage points to 5.6%. The one-year deposit rate will come down 0.25 percentage points to 2.75%.

This demand side move follows a series of supply side policies that included short-term liquidity operations that used repurchase agreements and reverse repos with maturities of seven-days or less to add cash to the system; the creation of a standing lending facility to provide one- to three-month cash to banks; a pledged supplementary lending tool that provided funds for lending in the housing sector; and, most recently, the creation of a medium-term lending facility in September that put 769.5 billion yuan into the banking system in September and October.

The European Central Bank matched China's action today with its usual combination of small actual moves and big rhetoric. In a speech in Frankfurt today, ECB president Mario Draghi once again promised to do “what we must to raise inflation and inflation expectations as fast as possible, as our price-stability mandate requires.” The bank's board of governors next meets in two weeks, and today, European financial markets are reading Draghi's remarks as a promise to take stronger action to stimulate growth and inflation in the EuroZone if current measures don't do the job.

And speaking of current measures, the central bank began its recently announced program of asset purchases today by buying asset-backed securities backed by Dutch home loans.

On the rhetoric and the action, European stocks rallied with the German DAX up 2.62% and French CAC 40 ahead 2.67%.

Of course, on Draghi's promise to do more, which would weaken the euro, that currency fell by 1.24% against the dollar to $1.2383.

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