This weekend, China’s central bank cut interest rates for the second time in three months.
In common with many other countries, China is living in fear of deflation. Producer prices (prices at the factory gate) have been falling for three years now. Meanwhile, the consumer price index rose by just 0.8% year-on-year. Hence the rate cut.
But things could get a lot tougher before they get better.
And oddly enough, that could be good news for investors in China.
How currency wars are making life difficult for exporters
If you live in the US or the UK, then your main question about interest rates right now is probably: “When will they go up?”
But that’s becoming an increasingly unusual position. Europe and Japan are still very near the start of their money-printing experiments – both are widely seen as likely to print more money before too long. Elsewhere, interest rates are being slashed to record-low levels. Australia has started cutting again, for example.
The slide in oil prices has left inflation at record lows in many areas. That’s given central banks all the excuse they need to trim rates.
But there’s something else going on in the background – ‘currency wars’. Two of the biggest, most powerful exporters in the world are currently hammering their currencies. Japan’s money printing programme has devalued the yen rapidly. And on the other side of the world, fear over Greece and European Central Bank money printing have ensured that Germany gets to use a currency that is far weaker than its own economic strength justifies.
If you’re an exporter in any other part of the world, this is horrible. If your country depends on selling goods to other nations, you’ve got a big problem here. You might not be able to compete on German quality, but you can certainly compete on price.
That’s no longer the case. A weak and falling euro has made Germany hyper-competitive.
That’s pretty grim news for anyone with a large export sector. China is trying to move towards more of a consumer-led economic model, but it still has a large manufacturing sector – which is currently shrinking. And last year, the annual pace of growth in China slowed to the worst level since 1990.
So it’s little wonder that the People’s Bank of China (PBoC) – the central bank – cut interest rates on Saturday. The one-year lending rate has been cut by 0.25 percentage points to 5.35%.
The PBoC also made it slightly easier for banks to compete with one another for deposits from savers – “a key step towards interest rate liberalisation”, notes Julian Evans-Pritchard of Capital Economics.
Evans-Pritchard adds that the February manufacturing sector data was actually better than expected. Although the official data suggested that the manufacturing sector shrunk again in February, the reading edged up compared to January.
Yet, “even after Saturday’s rate cut, policymakers will need to do a lot more to prevent growth slipping next quarter.”
The problem is that this “rate cut is unlikely to result in much looser monetary conditions.” It might help companies that already have debt, by lowering the rate on that debt a little. But “the binding constraints on bank lending are quantitative restrictions such as loan-to-deposit ratios and official lending quotas. As a result, rate cuts do not in themselves do anything to boost lending.”
In short, expect more action by the PBoC.
Why you should hang on to China
This all sounds rather gloomy for China. However, the thing is, as we’ve seen everywhere else on the planet, when you cut interest rates and devalue your currency, one thing tends to happen – asset prices go up.
And while Chinese stocks have rallied strongly over the past year or so, that could certainly continue if the central bank decides it needs to act more aggressively to tackle deflation. So you should hang on to any investments in China you have – and get exposure to the market if you don’t already.
In the next issue of MoneyWeek magazine (out on Friday), Jonathan Compton looks at China’s woes, and what it’s likely to do about them – and how you can profit from it all. If you’ve not already subscribed, find out how to get your first four issues free here.
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