China’s first interest-rate cut in more than two years has domestic reasons behind it and international ramifications ahead of it.
As the world’s second-largest economy heads toward its slowest full-year expansion in almost a quarter century, the People’s Bank of China unexpectedly reduced its deposit and lending rates, effective Saturday.
Friday’s shifts align the People’s Bank with the European Central Bank and Bank of Japan in delivering fresh economic stimulus even as the U.S. Federal Reserve shelves quantitative easing and looks set to raise interest rates next year. The policy divergence that will likely mark 2015 is growing wider by the week.
Hours before the announcement in Beijing, ECB President Mario Draghi underscored the recent tone by pledging to gun inflation “as fast as possible.” Only a month since investors were questioning the potency of policy makers, Europe’s stocks jumped to a seven-year high today.
By siding with the stimulators, the Chinese may provide some support for ailing global demand if the easier policy encourages its consumers to snap up foreign goods. It could also provide a brake on falling commodity prices, with Brent crude and West Texas Intermediate now bound for their first weekly gains since September.
The downside is that having previously allowed the yuan to climb, China may be joining a renewed currency war in which nations seek to steal inflation and demand from abroad by encouraging their exchange rates to fall.
At ADM Investor Services International Ltd. in London, strategist Marc Ostwald said that’s what’s happening after the yuan rose 10 percent against the Japanese yen since the middle of October, aided by the BOJ’s intensifying of quantitative easing.
“The timing of this move looks to be as much about the sharp appreciation of the yuan versus the yen as the fact China’s economy” is slowing, Ostwald said in a report to clients.
Pressure will now be on South Korea and others in the Southeast Asian region to respond with their own easing of monetary policy or risk their currencies rising and demand for their exports slowing, he said. A rate cut from the Reserve Bank of India is also now more likely, he said.
“This sort of currency war is really not at all helpful,” said Ostwald.
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