China seen cutting key rates from September but moves likely gradual

Deteriorating Sino-U.S. trade ties and interest rate reforms are fueling speculation China will start cutting key rates from next month, but bankers expect borrowing costs to come down only gradually, offering limited support for the slowing economy.

Chinese policymakers need to kickstart flagging investment to save jobs, but big rate cuts could fuel a further build-up in debt and squeeze banks’ profit margins, heightening financial sector risks.

Still, as the economy cools, analysts say landmark reforms launched last week have paved the way for the first cuts in major China policy rates in four years, with a move seen by mid-September, coinciding with expected easing by the U.S. Federal Reserve.

Initial rate cuts are expected to be modest, however, as banks and regulators get used to the new, more market-oriented loan pricing system. The People’s Bank of China (PBOC) will not push lenders too hard to lower rates at first, analysts said.

To reduce the pressure on banks, the central bank is expected to first reduce their funding costs by lowering the rate on its medium-term lending facility (MLF). That will open the door for a cut in the PBOC’s new benchmark lending rate, the loan prime rate (LPR), the next time it is set on Sept. 20. The MLF forms the basis for the new LPR rate, but banks can add a premium to reflect funding costs and credit risks.