China's Worst Deflationary Streak Since 1999
Former Central Bank Chief's Admission
China's former central bank chief, Yi Gang, recently admitted that the country should combat deflation. The Chinese economy is currently experiencing its worst deflationary streak since 1999, which is putting a strain on corporate profits, wages, and asset prices. Yi Gang stated in Shanghai that China should now concentrate on combating deflationary pressure. This statement is in stark contrast to the People’s Bank of China's (PBOC) previous restrained efforts in monetary easing. The PBOC has indicated multiple times that it would avoid any drastic easing.
The PBOC has been hesitant to aggressively cut interest rates due to concerns about currency weakness and banks' profit margins. The head of the PBOC's monetary policy department warned about the limitations on further decreasing deposit and lending rates. It is likely that the central bank will reduce banks' reserve requirements before deciding to cut its policy rate again.
Bearish Sentiment in Financial Markets
Investors in financial markets are becoming increasingly bearish, seeing no immediate relief from China's economic woes. Although the yuan has been boosted by the anticipation of a rate cut by the Federal Reserve later in the month, the risk-off sentiment remains dominant in equity and bond markets.
The benchmark CSI 300 index fell to its lowest level since early February, around the same time China unexpectedly replaced the chief of its stock-market watchdog during a market sell-off. Last week, JPMorgan Chase withdrew its buy recommendation for Chinese stocks, following similar moves by UBS Global Wealth Management and Nomura. Despite the PBOC's constant pushback, investors continue to invest in government bonds. The yield on the most actively traded 10-year government bond reached a record low last Wednesday.
Reducing Mortgage Rates to Combat Deflation
China's best chance to combat persistent deflation and the property slump may be to quickly reduce mortgage rates. Financial regulators have suggested reducing rates on outstanding mortgages nationwide by approximately 80 basis points. The first cut may occur in the coming weeks.
In May, the PBOC eased mortgage rules and provided 300 billion yuan ($42 billion) of funding to purchase unsold homes. However, a Bloomberg index of Chinese developer stocks has dropped by more than a third since then as these efforts failed to boost home sales. The new plan targets existing borrowers and may be the PBOC's best opportunity to shift market sentiment.
Bottom Line
China's economy is facing its worst deflationary streak since 1999, a situation that is putting pressure on corporate profits, wages, and asset prices. The country's former central bank chief has called for action to combat this deflation, which is a significant shift from the PBOC's previous stance. With bearish sentiment dominating financial markets and the property market in a slump, the proposed solution is to reduce mortgage rates.
What are your thoughts on this situation? Do you think the proposed solutions will be effective? Feel free to share this article with your friends and discuss. Don't forget to sign up for the Daily Briefing, available every day at 6pm.
