PBoC's RRR cut should reduce interest rates - ING

Iris Pang, the economist for Greater China at ING, notes the PBoC announced a 0.5 percentage point cut to the RRR effective in two batches on 15 October and 15 November. 

• "The central bank estimates that the cash released will be around CNY900 billion, of which CNY 100 billion will come from the targeted RRR cut. 
• As the cut will release CNY900bn, which is equivalent to 85% of new yuan loans in July, the impact on interest rates should be obvious.
• We expect that the SHIBOR curve will shift downward. As we expect another RRR cut in the fourth quarter, the SHIBOR curve should fall more at the front end than the back end, which should mean a flatter curve.
• The same should apply to China's sovereign bond curve.
• To benefit small firms, the prerequisite is that:

1. Either small firms have already borrowed a loan linked to SHIBOR. This doesn't seem very popular for small loans, so we expect few small firms to benefit from this channel
2. Or small firms are willing to borrow, in which case they would benefit from the lower interest rate.

• As we expect the RRR cut to reduce interest rates, this raises the question of whether USD/CNY will be affected. We think the correlation between interest rates and the exchange rate in China is still weak due to its capital controls and semi-open capital account. 
• Even if there is some impact on the exchange rate through the semi-open capital account, this will likely be offset by a possible Federal Reserve interest rate cut in 4Q19.
• As such, we keep our forecasts for USD/CNY at the end of 2019 at 7.20 and the range forecast at 7.05-7.50. 
• The next RRR cut announcement may be made in December, and the effective date could be in January 2020, as the trade war continues to hit the Chinese economy. The impact will be the same, i.e. to lower interest rates in general to prevent small firms from defaulting."