After the largest single drop in history of LPR

In October, the LPR was lowered by 25BP, marking the implementation of incremental financial policies within less than a month. On September 24, at a press conference by the State Council Information Office, Governor Pan Gongsheng announced three financial policies: first, to lower the reserve requirement ratio and policy interest rates; second, to reduce existing housing loan rates and unify the minimum down payment ratio for housing loans; third, to introduce new monetary policy tools to support the stable development of the stock market. With the 25BP reduction in the October LPR rate, the financial policies announced in September have all been implemented. The urgency of the current policy changes is evident from the announcement to implementation within a month.

Although the significant reduction in LPR had been anticipated, the extent of the cut exceeded previous expectations. At the Financial Street Forum Annual Meeting on October 18, Governor Pan Gongsheng had already forecasted a 20-25BP decrease in this month's LPR. However, both the 1-year and 5-year and above LPR rates were reduced by the maximum amount as previously announced, marking the largest single reduction since the LPR reform in 2019 and surpassing market expectations, demonstrating the strength and determination of monetary policy to support the economy.

A significant reduction in LPR at once may also mean that commercial banks will quickly implement capital replenishment. Based on the balance sheet of commercial banks in the first half of 2024, we estimate that a 10bp reduction in the 1-year and 5-year LPR corresponds to a narrowing of the net interest margin by around 5bp and 1bp, respectively. With this unified 25BP LPR cut, the expected narrowing of the net interest margin is around 15bp. Given that the net interest margin of banks had already decreased by 15bp in the first half of this year, coupled with the reduction in existing housing loan rates, this round of monetary easing will have a significant impact on the net interest margin of banks, necessitating urgent measures to replenish commercial bank capital, which is expected to be implemented as early as November.

The switch in the phase of monetary policy objectives may focus on promoting price increases in the future. Since the beginning of the year, monetary policy has taken into account multiple objectives such as stabilizing the exchange rate, net interest margin, and preventing asset bubbles. With the exchange rate rising to around 7.1, the convergence of M2 and GDP growth rates, and the imminent implementation of capital replenishment for commercial banks, the current focus of monetary policy may shift towards promoting price increases. During his speech on October 18, Governor Pan once again mentioned "... in terms of target system, promoting a reasonable increase in prices will be an important consideration...".

It is expected that social financing and credit growth rates will rebound. Historically, an increase in prices corresponds to a recovery in real demand, and credit expansion often leads the improvement in real demand. Based on historical experience, a stabilization and rebound in medium and long-term loans to enterprises often correspond to a stabilization in fixed asset investment growth and a rebound in the Producer Price Index (PPI). Even during the period of overcapacity in 2013-2014, this empirical rule largely applied. Therefore, the lever for monetary policy to promote price increases is to drive the rebound in social financing and credit growth rates.

The window of loose monetary policy is still open, with room for further action in the future. The current rate-cutting cycle by the Federal Reserve has just begun, and domestic real demand has not significantly improved. Both overseas and domestic macro environments with loose monetary conditions remain unchanged, especially compared to historical synchronized easing cycles in the US and China (2008, 2019-2020). As overseas rate cuts take effect, domestic monetary policy will also loosen, although not entirely in sync. The window for domestic loose monetary policy remains open, with further room for policy action.

Risk Warning: Unexpectedly loose domestic monetary policy, Federal Reserve pauses rate cuts, and inflation rises unexpectedly.

Author: Minsheng Macro Wu Bin, Source: Chuan Yue Global Macro (ID: gh_fa80a5ed2401), Original Title: "After the Largest Single LPR Cut in History"