On November 5, the People's Bank of China (the PBC) issued RMB400 billion of one-year medium-term lending facility (MLF) and cut the MLF interest rate to 3.25% from 3.3%. Today, the maturity scale of MLF is RMB403.5 billion. The PBC unexpectedly cut the interest rate of one-year Medium-term Lending Facility (MLF). As it is far beyond the market expectation, A share rises sharply on the day in a response. Market participants generally believe that in the "balance" of the PBC, "stabilizing growth" overweighs "controlling inflation". 

According to the announcement issued by the PBC, on November 5, 2019, the PBC issued RMB400 billion of one-year MLF, basically equivalent to the amount due on that day. The OMO interest rate was 3.25%, down 5 base points compared with the previous period. 

"Stabilizing growth" plays a more important role. 

This marks the first reduction of the one-year MLF interest rate by the PBC since April 2018. Before this, it was widely expected that as there is an inflation potential, the PBC will probably continue to stabilize the interest rate while operating MLF, or offer "MLF+TMLF" portfolios. Market participants believe that the reduction of MLF interest rate shows that the PBC attaches more importance to "stabilizing growth" than "controlling inflation". 

Market analysts believe that the PBC is put in front of a dilemma. First, the PBC is facing the downward pressure on the real economy. In October, China's PMI (Purchasing Managers' Index) continued to slow down, dropping by 0.5% to 49.3% month-on-month. Second, there is a hidden risk of inflation. The Consumer Price Index (CPI) grew by 3% year on year in September. 

Wang Yifeng, chief banking analyst of Everbright Securities, said that the PBC paid more attention to "stabilizing growth" than "controlling inflation" and that the reduction of the MLF interest rate was to intensify support for the real economy. 

Mingming, chief analyst of fixed income of CITIC Securities, believes that there are several reasons for the slight reduction of the MLF interest rate. First, the real economy is under great pressure. Second, "pork inflation" will not pose a restriction on the monetary policy, given the monetary policy mainly focuses on core inflation. Third, recently, the interest rate in the bond market increases significantly. For example, some enterprises cancel the issuance of bonds, which affects the financing of the real economy. The cut of the interest rate by the PBC at the proper time benefits the stabilization of the bond market and provides financial support for the real economy. It is widely believed that the move of the PBC yesterday will be good for the stock market and bond market. 

The LPR quotation is expected to be lowered in November. 

After the reform of the LPR mechanism, it is linked with the MLF interest rate and as a result, the MLF interest rate becomes the "anchor of interest rate". Market participants believe that the reduction of the MLF interest rate by the PBC is to guide the drop of the LPR quotation and then the drop of the corporate financing interest rate. The LPR quotation is expected to be cut in November. 

Wang Yifeng predicted that in November, LPR would be cut by 5 base points accordingly, representing the first practice since the establishment of "MLF-LPR" linkage mechanism. "The PBC hopes to further dredge the transmission mechanism of monetary policy to give more support to the real economy. Besides, as the LPR is guided downward, more market strengths will be employed to promote the services for small and micro private enterprises." 

In addition, since this year, as global economic growth slows down, many central banks have cut interest rates in response, and the FRB has cut interest rates three times in a row this year. This reduction of the MLF interest rate whipped out discussion on whether China starts the interest rate reduction cycle. 

Liao Zhiming, chief banking analyst of TF Securities, believes that if the CPI pressure is significantly relieved in the middle of next year, it is expected that the MLF still has 30 base points to fall. But Wang Yifeng believes that although in spite of the restraints of market expectations, cross-border capital flows and the coordination of international macro policies, the "self-centered" tone of the monetary policy of the PBC will remain unchanged. 

"The PBC did not follow the "interest rate cut" wave in the early stage. This reduction of the MLF interest rate by 5 base points is quite conservative. It indicates that the monetary policy of the PBC still remains stable and values the space of the traditional monetary policy. In the future, the MLF still has a space to drop. However, it is more likely to employ structural tools such as targeted reduction of deposit reserve ratio in the next stage", said Wang Yifeng. What is the message behind the unexpected "rate cut"? How will bond market and stock market proceed? 

The "rate cut" is late but comes. 

In August this year, the PBC reformed and improved the formation mechanism of the Loan Prime Rate (LPR) in the loan market and had the quotation benchmark of LPR directly linked to the Medium-term Lending Facility (MLF). The monetary policy price instrument also changed from the past legal benchmark interest rate of loan to MLF interest rate. What the market concerns is whether the core of the PBC's interest rate cut changes to the MLF interest rate reduction. 

Before that, the expectation of MLF interest rate cut in September was unfulfilled many times. On September 24, Yi Gang, governor of the PBC, said at a press conference that "We are not in a rush to have large interest rate cuts and quantitative easing policies as some other central banks have done. After a comprehensive analysis of the domestic situation and the international background, China's monetary policy should remain stable and steady." 

On October 21, according to the third quotation of the new LPR, the quotation of varieties with a term of one year and five years above holds the line with that in September and the expectation of a sustained fall evaporated. As the reduction of interest rate is expected to cool, the PBC cut the interest rate of one-year MLF by 5 base points to 3.25% on November 5. 

The bond market rebounded sharply on the news and treasury bond futures rose sharply across the board. As of closing in the afternoon, the main contracts of ten-year bonds, five-year bonds and two-year bonds went up by 0.38%, 0.18% and 0.12% respectively. 

In the capital market, A share saw an percussive increase. The Shanghai Securities Composite Index rose by 0.54% to 2991.56 at closing, having three consecutive increases, once peaking at 3000; the SZSE Component Index rose by 0.71% to 9938.61; the Growth Enterprise Index went up by 0.79% to 1713.29; the SSE 50 Index increased by nearly 1% during the session and went beyond the 3048 high, a new high since February 7, 2018. The two markets achieved a turnover of RMB481.5 billion, slightly up compared with the previous day. The net inflow of capital from the north kept for 9 consecutive days and amounted to RMB5.2 billion. 

Messages from the "Rate Cut" 

From the external environment, since this year, as global economic growth slows down, many central banks have cut interest rates in response, and the FRB has cut interest rates three times in a row this year. 

Wen Bin, chief researcher of China Minsheng Bank, said in an interview with the International Financial News that the interest margin between China and the US on 10-year treasury bonds has also increased from 50bp when the FRB first cut interest rates to 150bp at present. The increased interest margin has made the RMB/USD exchange rate recover, providing a space for the PBC to cut interest rates. 

Today, the onshore RMB closed at 6.9975 at 16:30 against the USD, up 327 base points from the previous session, plunging beyond 7 per USD for the first time since August 5. The central parity rate between USD and RMB dropped by 3 base points to 7.0385. 

According to the analysis of the macro team headed by Li Chao of Huatai Securities, China's economy is under the downward pressure coupled with staged "stagflation" of high inflation. In the ultimate goals of the PBC, the conflict between stabilizing growth and controlling inflation makes the monetary policy decision-making harder. Given there are many ultimate goals, the monetary policy focuses on the main contradictions. The current monetary policy of the PBC is confronted with a tough choice between stabilizing growth and controlling inflation. 

Wen Bin said that from the perspective of inflation, the rapid rise of pork prices pushed up food prices, posing pressure on CPI. The CPI is expected to rise by 3.1% year on year in November, but is generally controllable. On the contrary, PPI has seen negative growth for three consecutive months and is expected to continue to drop year on year in November. The corporate profitability is under pressure. As the real estate regulation is intensified, the real estate price remains stable as a whole. Given the above, inflation and asset prices should not be considered as the main factors to cut the policy rate. 

According to the formula of LPR formulation, LPR equals to the sum of MLF interest rate + plus point of interest rate and either the change of the MLF interest rate or the change of its plus point will lead to LPR change. Some insiders believe that the LPR in October remained flat compared with the previous month. The reduction of the MLF interest rate by the PBC carries the message of lowered social financing cost to the market. 

Li Qilin, chief economist of Lianxun Securities, said that in the absence of market expectation management, the PBC cut the MLF interest rate under the context that banks lack enough will to continue to reduce the interest margin to cut the LPR due to the restrictions of the cost of debt. As the short-term economic growth challenges the bottom line of the policy and there is a large pressure on stabilizing growth, the PBC's move to cut the MLF interest rate as a pricing benchmark is more effective to adjust the LPR and expedites the reduction of the financing cost of entities, and the stabilization of employment and investment. 

Wen Bin believes that the distribution of an equivalent amount of due MLF indicates that the PBC will continue to adhere to a prudent monetary policy to ensure reasonable and sufficient market liquidity. "At the same time, the cut of 5 base points of 1-year MLF interest rate meets the market expectations and indicates that the PBC plays a role in counter-cyclic adjustment of monetary policy and functions positively in reducing the financing cost of the real economy, and stabilizing and expanding domestic demand." 

According to Mingming, chief analyst of fixed income of CITIC Securities, the interest rate of the bond market rises significantly recently, including the cancellation of issuance of bonds by some enterprises, and affects the financing of the real economy. Given this, the interest rate cut by the PBC will help stabilize the bond market and plays a role of financial support for the real economy. 

The reduction of 5BP of the MLF gives three messages. 

1. Counter-cyclic adjustment of monetary policy to stabilize growth. 

According to data released by the National Bureau of Statistics, China's economy grew by 6.0% in Q3, 0.2% down from that of Q2. Some analysts believe that there is a necessity and space to relax the monetary policy. 

2. Stabilize corporate bond financing. 

According to Mingming, chief analyst of fixed income of CITIC Securities, recently, the bond market has been affected by the inflation expectation and risk preference, and the relatively significant increase of the interest rate and the cancellation of bonds by some enterprises produces a certain impact on corporate bond financing. The cut of the MLF interest rate is also helpful to stabilize the bond market and effectively back corporate financing and the operation of the real economy. 

3. Guide the LPR to drop. 

In August this year, the PBC pushed forward the market-oriented reform of loan rates. After the reform, the LPR is determined by reference to MLF, while the loan rate is based on LPR. By now, three LPR quotations have been made. 

On the whole, in the past three months, the decrease of LPR slowed down. Specifically, on August 20, the one-year LPR and the five-year LPR decreased by 10bp and 5bp respectively. On September 20, the one-year LPR decreased by 5bp, while the LPR with the term over five years remained unchanged. On October 21, neither of them changed. In October, LPR remained stable, indicating that it is hard for commercial banks to further reduce their capital cost. On November 20, the fourth quotation of LPR will be announced. Besides, the cut of the MLF interest rate by the PBC will help to guide the decrease of LPR.