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The People’s Bank of China plans to cut interest rates this year as it makes a historic shift toward a more orthodox monetary policy to bring it closer in line with 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.
He added that he would prioritize “the role of interest rate adjustments” and move away from “quantitative targets” for credit growth in what would constitute a transformation of Chinese monetary policy.
Most central banks, such as the Fed, have only one policy variable, the key interest rate, which they use to influence the demand for credit and activity in the economy.
In contrast, the KBP not only sets a range of different interest rates, but also gives banks informal guidance on how much they should expand their loan books.
While such guidance was its most important tool in managing the economy for decades – as loans were directed to high-growth sectors such as manufacturing, technology and property – officials within the PBoC believe reform is now urgent.
“Rate reform is likely to be the real focus of the PBoC in 2025,” said Richard Xu, chief China financial analyst with Morgan Stanley in Hong Kong. “China’s economic development urgently needs to shift from a mindset focused only on expanding the size of the market (of banks’ loan books).
Credit demand has fallen due to a prolonged slowdown in the property market. The PBoC also fears that credit growth targets lead to indiscriminate lending without regard to risk, which is futile in the long run.
“In line with the requirements 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 controlling interest rates and improve the formation and transmission of market-oriented interest rates.”
As part of the regime change, the KBP clarified last year that its main policy instrument would be the seven-day inverse repo rate rather than the number of interest rates it has relied on to date.
A reduced emphasis on credit growth targets could curb the rampant overcapacity in China that has led to bad debt in the country and disruptions to global industries such as steel.
But the central bank has been struggling to implement its shift toward interest rates because 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 revive 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 that affects mortgage prices three times.
The moves came in the context of President Xi Jinping’s pledge to achieve economic growth of 5 percent, despite problems in China’s property sector and trade tensions with the US.
PBoC Governor Pan Gongsheng and his predecessors Yi Gang and Zhou Xiaochuan have pushed for risk-based loan pricing in recent meetings with officials from some of China’s biggest banks, according to those present.
Bankers at the meetings warned of potential confusion in pricing long-term loans as the market gets used to the guidelines from the KBP, highlighting the challenge of transitioning to the new system.
For international investors, if the PBoC is successful, then Chinese 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 also bought government bonds on the open market to inject money into the financial system in 2024, the same way the Fed conducts its policy.
Analysts said the PBoC still lacks some key ingredients for a system based on interest rates, such as a schedule of routine, publicly released meetings to make policy decisions.
Without such guidance, “market participants may find themselves guessing what will happen next,” said Haibin Zhu, China economist at JPMorgan Chase.
