Central Bank Q3 Monetary Policy Report 7 Signals

Event: On November 9th, the central bank released the "2024 Q3 China Monetary Policy Implementation Report" (hereinafter referred to as the "Report"), which includes four special columns: "Review and Outlook of China's Money Supply Statistical System," "Improving the Financial Technology Service System," "Maintaining Competitive Order and Improving Policy Interest Rate Transmission," and "Development of Direct Financing and Transformation of the Monetary Policy Framework."

Core Viewpoints: This report largely continues the statements from the central bank's press conference on September 24th, the Central Political Bureau meeting on September 26th, etc., including "adhering to a supportive monetary policy stance and increasing the intensity of monetary policy regulation." However, there are also many new changes, especially regarding prices, exchange rates, and the monetary policy framework, with significant new information in the four columns. Looking ahead, it continues to indicate that the underlying logic of current policies has changed, particularly with the central government's leverage increasing significantly. Specifically regarding monetary policy, the central bank is approaching direct "intervention," and a Chinese version of quantitative easing is on the way, with further reserve requirement ratio cuts expected by the end of the year and possible interest rate cuts in the first quarter of next year.

1. In comparison, this report largely continues the expressions from the previous Q2 monetary policy report, the September 24th central bank press conference, and the September 26th Central Political Bureau meeting, including emphasizing that "a prudent monetary policy should be flexible, moderate, precise, and effective; firmly adhering to a supportive monetary policy stance and increasing the intensity of monetary policy regulation."

2. There are also many new changes, especially regarding prices, exchange rates, and the monetary policy framework: greater emphasis on stabilizing prices, removing "maintaining price stability," and emphasizing promoting a "reasonable rebound" in prices as an important consideration for monetary policy (previously it was "moderate rebound"); regarding exchange rates, the phrase "resolutely correcting pro-cyclical behavior" was removed and replaced with "strengthening expectation guidance," indicating that future exchange rate regulation will be more flexible and may focus more on balancing exchange rate stability with other goals (such as responding to potential tariff escalations); new measures include "appropriately narrowing the width of the interest rate corridor," among others. Additionally, there is a lot of new information in the columns, with Column 3 comprehensively introducing the new market-oriented interest rate system; Column 1 noting that the statistical caliber for M1 and M2 will be adjusted; and Column 4 explaining the significant fluctuations in M2 this year.

3. Specifically, there are seven major signals:

Signal 1: The central bank remains concerned about the global economy, believing that "the global economy continues to exhibit low growth," and "the recovery process remains weak," especially noting that "the uncertainty of the international geopolitical situation is increasing, which may drag down global trade and investment growth"; it remains cautious about the domestic economy, continuing to emphasize that "the foundation for economic recovery needs to be consolidated," primarily due to "increasing uncertainty in the external environment, the domestic economy being in a critical stage of structural adjustment and transformation, and weak social expectations," among other factors.

Signal 2: Regarding global inflation, the central bank believes that "inflation in major developed economies is generally declining," but also points out that "the rebound in commodity prices and persistent service inflation may hinder further declines in inflation." For domestic inflation, the central bank states that "after the recent introduction of a package of incremental policies, the stimulating effect on effective demand and the macro economy will gradually become apparent, and there is still a basis for moderate price recovery," and expects that "CPI is likely to continue a moderate recovery trend this year, and the decline in PPI will also generally narrow." The central bank has newly emphasized "promoting a reasonable rebound in prices as an important consideration for grasping monetary policy."Signal 3: The monetary policy tone basically continues the statements from the previous September 24th central bank press conference and the September 26th Politburo meeting, including "a prudent monetary policy should be flexible, appropriate, precise, and effective; firmly adhere to a supportive monetary policy stance, and increase the intensity of monetary policy regulation," etc. However, there are also many new changes, including the removal of "strengthening counter-cyclical adjustments" from the Q2 report; a greater emphasis on prices, deleting "maintaining price stability," and emphasizing promoting a "reasonable rebound" in prices as an important consideration for monetary policy (previously it was "moderate rebound"); in terms of exchange rates, the phrase "resolutely correct pro-cyclical behavior" was removed and replaced with "strengthen expectation guidance," etc.; a new addition is "researching the appropriate narrowing of the width of the interest rate corridor."

Signal 4: The weighted average loan interest rate in the second quarter further declined, with both residential mortgage rates and corporate loan rates hitting historical lows again.

Signal 5: Column 3 "Maintaining Competitive Order and Improving Policy Interest Rate Transmission" points out that China has basically formed a market-oriented interest rate formation and transmission mechanism, as well as a relatively complete market-oriented interest rate system.

Signal 6: Column 1 "Review and Outlook of China's Money Supply Statistical System" states that "the statistical caliber of money supply is not fixed," and the central bank will subsequently "research the revision plan for money supply statistics" based on the development of China's financial market and financial innovation, with M1 and M2 calibers likely to undergo adjustments.

Signal 7: Column 4 "Development of Direct Financing and Transformation of Monetary Policy Framework" explains the significant fluctuations in M2 this year, which are mainly related to the diversion and return of deposits.

The main text is as follows:

Signal 1: The central bank remains concerned about the global economy, believing that "the global economy continues to exhibit low growth," and "the recovery process is still relatively weak," especially as "the uncertainty of the international geopolitical situation is increasing, which may drag down global trade and investment growth"; it remains cautious about the domestic economy, continuing to emphasize that "the foundation for economic recovery and improvement still needs to be consolidated," mainly due to "the rising uncertainty in the external environment, the domestic economy being at a critical stage of structural adjustment and transformation, and weak social expectations," etc.

Regarding the global economy: The central bank is still worried, believing that "the global economic recovery process is still relatively weak," and cites predictive data from the International Monetary Fund (IMF) and others as examples (the forecast for global economic growth in 2024 is 3.2%, 2.6%, and 3.2%, lower than the historical average of 3.8% from 2000 to 2019). At the same time, the central bank is also concerned about geopolitical issues, stating that "currently, two-thirds of countries and regions have completed elections, and the domestic and foreign policies of developed economies such as the United States may undergo adjustments," and in the future, "the uncertainty of the international geopolitical situation is increasing, which may drag down global trade and investment growth."

Regarding the domestic economy: The central bank remains cautious, believing that "the foundation for economic recovery and improvement still needs to be consolidated," mainly due to external "environmental uncertainty rising, risks and challenges increasing, and the momentum of world economic growth slowing," and internal "the economy is at a critical stage of structural adjustment and transformation, with cyclical and structural contradictions intertwining," etc. However, it also points out that in the medium term, "China's economic development has strong resilience, enormous potential, and solid support."Signal 2: Regarding global inflation, the central bank believes that "inflation in major developed economies has generally receded," but also points out that "the rebound in commodity prices and persistent service inflation may hinder further declines in inflation." For domestic inflation, the central bank states that "after the recent introduction of a package of incremental policies, the stimulating effect on effective demand and the macro economy will gradually become apparent, and there is still a basis for a moderate rise in prices." It is expected that "CPI is likely to continue a moderate upward trend this year, and the decline in PPI will also generally narrow." The central bank emphasizes "promoting a reasonable rise in prices as an important consideration in grasping monetary policy."

Regarding global inflation: The central bank believes that "inflation in major developed economies has generally receded," but also points out that "the rebound in commodity prices and persistent service inflation may hinder further declines in inflation." On one hand, "the decline in commodity prices was the main driving factor behind the previous decline in inflation, but the current geopolitical situation is becoming more complex, and international commodity prices face upward pressure." On the other hand, "wage growth in the US and Europe remains relatively fast and exceeds the increase in consumer prices, making service inflation potentially more stubborn."

Regarding China's inflation: The central bank points out that "after the recent introduction of a package of incremental policies, the stimulating effect on effective demand and the macro economy will gradually become apparent, and there is still a basis for a moderate rise in prices." It is expected that "the fourth quarter will gradually enter the consumption peak season, with shopping festivals approaching and early preparations for the Spring Festival being significant consumption drivers." It is anticipated that "CPI is likely to continue a moderate upward trend this year, and the decline in PPI will also generally narrow." In the medium to long term, "China's economic transformation and industrial upgrading are steadily advancing, the economic supply-demand relationship is expected to become more balanced, monetary conditions are reasonable and moderate, residents' expectations are stable, and there is a solid foundation for maintaining basic price stability."

Signal 3: The monetary policy tone basically continues the statements from the previous September 24th central bank press conference and the September 26th Central Political Bureau meeting, including "a prudent monetary policy should be flexible, moderate, precise, and effective; firmly adhere to a supportive monetary policy stance, and increase the intensity of monetary policy regulation." However, there are also several new changes, including the deletion of "strengthening counter-cyclical adjustments" from the Q2 report, placing more emphasis on prices, and highlighting the promotion of "reasonable price recovery" as an important consideration in grasping monetary policy (previously it was "moderate recovery"). In terms of exchange rates, the phrase "resolutely correcting pro-cyclical behavior" has been removed and replaced with "strengthening expectation guidance," and new additions include "studying the appropriate narrowing of the width of the interest rate corridor." Looking ahead, it continues to suggest that the underlying logic of current policies has changed, especially as the central government's leverage space has clearly opened up, and the central bank is approaching direct "intervention," with China's version of quantitative easing on the way.

Firstly, the monetary policy tone basically continues the statements from the previous September 24th central bank press conference and the September 26th Central Political Bureau meeting, including "a prudent monetary policy should be flexible, moderate, precise, and effective; firmly adhere to a supportive monetary policy stance, and increase the intensity of monetary policy regulation." The phrase "strengthening counter-cyclical adjustments" has been deleted from the Q2 report, but there is a tendency to believe that the underlying logic of current policies has changed, and monetary easing remains the general directionSecond, the emphasis on price levels has further increased, indicating that promoting a "reasonable rebound" in prices will be an important consideration for monetary policy. The Q2 statement referred to a "moderate rebound," and greater monetary easing can still be expected in the future.

Third, regarding exchange rates, the phrase "resolutely correct pro-cyclical behavior" has been removed and replaced with "strengthen expectation guidance," indicating that future exchange rate adjustments will be more flexible and will pay more attention to balancing exchange rate stability with other objectives (such as responding to potential tariff escalations);

Fourth, a new point has been added: "researching the appropriate narrowing of the width of the interest rate corridor." The framework for monetary policy regulation will be further improved. Currently, the monetary policy interest rate corridor is centered around the reverse repurchase rate, with the SLF rate and excess reserve requirement rate as the upper and lower limits, respectively, resulting in a relatively wide overall width. The previously established temporary reverse repurchase tools are expected to be formally confirmed as the new upper and lower limits of the interest rate corridor.

Signal 4: In the second quarter, the weighted average loan interest rate further declined, with both residential mortgage rates and corporate loan rates reaching historical lows. The report pointed out that the weighted average interest rate for newly issued loans in September was 3.67%, a decrease of 0.01 percentage points from the second quarter. Among these, the weighted average interest rate for corporate loans was 3.51%, down 0.12 percentage points from the second quarter, and the residential personal housing loan rate was 3.31%, down 0.14 percentage points from the second quarter, both hitting historical lows.

Signal 5: Column 3 "Maintaining Competitive Order and Improving Policy Interest Rate Transmission" pointed out that China has basically formed a market-oriented interest rate formation and transmission mechanism, as well as a relatively complete market-oriented interest rate system.

The special report elaborated on China's interest rate system, stating that the People's Bank of China influences money market rates (such as interbank certificate of deposit rates) and bond market rates (such as government bond yields) by adjusting the policy interest rate, which is the 7-day reverse repurchase operation rate, and affects deposit and loan rates (such as the Loan Prime Rate (LPR) and the bank deposit benchmark rate), thereby promoting consumption and investment, enhancing overall social demand, and supporting economic development. Compared to the previous dual policy interest rate system of reverse repurchase + MLF, the new interest rate system only determines the short end, namely the reverse repurchase rate, while the long end rate is formed based on the short end, resulting in a higher overall degree of marketization.

In addition, the central bank also pointed out that China's interest rates can "effectively transmit" overall, but "the transmission efficiency varies across different markets." Specifically, the money market and bond market are basically synchronized with the policy interest rate, but there is a significant deviation in the adjustment amplitude of deposit and loan rates compared to the policy interest rate, primarily due to intense market competition and severe "involution" among banks. The transmission efficiency of interest rates in the deposit and loan market affects the effectiveness of regulation and constrains the space for monetary policy. In the future, the central bank will continue to promote interest rate marketization reform, maintain market competition order, and improve policy interest rate transmission.

Signal 6: Column 1 "A Review and Outlook on China's Monetary Supply Statistics System" states that "the statistical caliber of monetary supply is not set in stone," and the central bank will "research the revision plan for monetary supply statistics" based on the development of China's financial market and financial innovation, with potential adjustments to M1 and M2 metrics.

The central bank pointed out that "monetary supply is the total of financial instruments that serve as means of circulation and payment at a certain point in time," and that "the statistical caliber of monetary supply is not fixed, but is dynamically adjusted mainly based on the liquidity of financial instruments and their alignment with the economy," in order to "better serve macro-financial analysis and monetary policy regulation." In recent years, "China's financial market and financial innovation have developed rapidly, leading to significant changes in the category of financial instruments that meet the definition of monetary supply, making it necessary to dynamically improve," including: first, the development of bank cards and mobile payments, with personal demand deposits also becoming highly liquid payment tools; second, the widespread use of non-bank payment institutions' reserve funds in daily payments, both of which could be studied for inclusion in M1 statistics to enhance the scope of monetary supply; third, M2 statistics should be adjusted in a timely manner in accordance with the changes in the liquidity of financial instruments.

The central bank is "seriously studying the revision plan for monetary supply statistics, and will release it at an appropriate time in the future, along with a suitable retrospective of historical data, continuously improving the completeness and sensitivity of monetary reflection of changes in economic activity." Additionally, the column continues to emphasize that "China's monetary policy framework will gradually downplay the focus on quantitative targets, treating the total financial volume more as an observational, reference, and expectation indicator, while placing greater emphasis on the role of interest rate regulation, continuously enhancing the adaptability and effectiveness of financial support for the high-quality development of the real economy."

Signal 7: Column 4 "Development of Direct Financing and Transformation of the Monetary Policy Framework" explains the significant fluctuations in M2 this year, mainly related to the diversion and return of deposits.

The column points out that "the diversion and return of deposits have affected the monetary creation of the banking system, causing significant disturbances to M2," with two main mechanisms: first, "when bank deposits flow into asset management products, non-bank institutions purchase interbank certificates of deposit, financial bonds, etc., which are not included in M2"; second, "non-bank financial institutions have more abundant funds, repaying existing bank loans and repurchases, or purchasing bonds held by banks, all of which will lead to a contraction of the bank's balance sheet, resulting in a corresponding decrease in derived deposits and M2."

Since the beginning of this year, due to the reduction in deposit rates, regulation of manual interest supplementation, and the rise in bond market prices, deposits have experienced an accelerated diversion towards wealth management and other asset management products, leading to a faster decline in M2; after the release of a package of incremental policy measures in September, expectations improved, the stock market rebounded, and some funds from wealth management and other asset management products flowed back to margin deposits of securities companies included in M2, boosting M2 growth.

Risk Warning: Unexpected changes in economic recovery, policy strength, external environment, etc.

Source: Xiong Yuan (ID:gh_b8da3439a34e),This article is sourced from XiongYuan Observation, original title: "New Requirements for Prices and Exchange Rates - Central Bank Q3 Monetary Policy Report 7 Signals [GuoSheng Macro XiongYuan Team]."

XiongYuan S0680518050004 Mu Renwen S0680523060001