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The People’s Bank of China plans to cut interest rates this year as it makes a historic shift toward more orthodox monetary policy to bring it closer to the U.S. Federal Reserve and the European Central Bank.
In comments to the Financial Times, China’s central bank said it was likely to cut interest rates from the current level of 1.5 percent “at an appropriate time” in 2025.
It added that it would prioritize “the role of interest rate adjustments” and move away from “quantitative targets” for credit growth, which would mean a transformation of China’s monetary policy.
Most central banks, such as the Fed, have only one policy variable, the benchmark interest rate, that they use to influence the demand for credit and activity in the economy.
The PBoC in contrast, it not only sets a multitude of different interest rates, but also provides unofficial guidance to banks on how much they should expand their loan books.
While such guidelines were his most important tool in management economy for decades – while lending has been funneled into high-growth sectors such as manufacturing, technology and real estate – officials within the PBoC believe reform is now urgent.
“Interest rate reform is likely to be the real focus of the PBoC in 2025,” said Richard Xu, chief China financial analyst at Morgan Stanley in Hong Kong. “China’s economic development urgently needs to shift from a mindset focused solely on increasing market size [of banks’ loan books].”
Demand for credit collapsed due to the long-term slowdown of the real estate market. The PBoC also fears that credit growth targets lead to indiscriminate lending without consideration of risk, which is wasteful in the long run.
“In line with the demands of high-quality development, these quantitative targets have been phased out in recent years,” the central bank said. “The PBoC will pay more attention to the role of interest rate control and improve the formation and transmission of market-oriented interest rates.”
As part of the regime change, the PBoC clarified last year that its main policy instrument would be the seven-day reverse repo rate, rather than the range of interest rates it had relied on until now.
A reduced emphasis on credit growth targets could curb the rampant overcapacity in China that has led to bad debt at home and disruptions in global industries such as steel.
But the central bank has struggled to implement its rate hike as the government wants to channel money into the high-tech and manufacturing sectors, which is easier under the old system of credit expansion.
Even as it tries to make a structural change in policy, the PBoC is also under pressure to reorient China’s economy.
During 2024, as part of the most aggressive stimulus package since the Covid-19 pandemic, the central bank cut the seven-day rate twice and the five-year rate three times, which affects mortgage prices.
The moves came amid President Xi Jinping’s pledge to achieve 5 percent economic growth despite problems in China’s real estate sector and trade tensions with the US.
PBoC Governor Pan Gongsheng and his predecessors Yi Gang and Zhou Xiaochuan pushed for risk-based loan pricing in recent meetings with officials from some of China’s biggest banks, according to participants.
Bankers warned at the meetings of possible confusion in the pricing of long-term loans as the market gets used to the PBoC’s guidance, highlighting the challenge of transitioning to the new system.
For international investors, if the PBoC is successful, then China’s monetary policy will begin to resemble the system they are used to in the US, Europe or Japan.
For the first time in two decades, the central bank bought government bonds in the open market to inject money into the financial system in 2024, the same way the Fed conducts its policy.
Analysts say the PBoC still lacks some essential ingredients for an interest rate-based system, such as scheduling routine, publicly announced meetings to make policy decisions.
Without such guidance, “market participants could be left guessing as to what will happen next,” said Haibin Zhu, China economist at JPMorgan Chase.
