From firefights to finetuning

Monetary policy to continue cautiously

• The latest Five-Year Plan pivots from “risk resolution” to “long-term mechanisms”. Deleveraging has been dropped from policy priorities, and the focus is on channelling domestic savings into tech, green energy, pensions, and digital assets. Further, a move, away from bank-loan dominance, towards equity, bonds, and securitised assets, has been signalled.
• Yet, expectations for broad-based easing would be foolhardy.
• Liquidity is to flow via targeted tools (MLF, PSL, relending), backed by hard assets (equipment, data centres, chips). Despite weak growth (Q3 2024 GDP +3.7%), and deflation, and irrespective of the Fed’s fan chart, the PBOC will likely opt for mild accommodation. Expect modest (10–20 bps in 2026) rate cuts, favouring incrementalism over big-bang stimulus.
• Banking sector pressures: net interest margin at 1.4% (below 1.8% floor); deeper cuts would risk eroding capital ratios. True bad-loan exposure closer to 4%; annual impairments consume nearly all pre-provision profits. Mortgage repricing and prepayment surge shrink high-quality assets. Rate cuts erode the deposit base. The stability of this retail funding franchise is more important to systemic safety than a few extra basis points of lending stimulus.
• Currency and capital dynamics: rate cuts risk yuan depreciation; spread with US near 80bps, a danger zone.
• The cadence of bond issuance affects banks. The PBOC uses bond purchases and timing of RRR cuts should manage fiscal issuance and liquidity.
• Behavioural lower bound: loan demand weak despite record-low rates; approval ratios down to 66%. Liquidity hoarded, not spent. This is far more about demand than supply, and it has very little to do with the price of credit. Additional cuts mostly redistribute income but do not expand credit.
• Baseline outlook: mild, targeted easing continues; sweeping stimulus unlikely, unless LGFV debt crisis forces emergency measures.
• Tail risk: local-government rollover failures could trigger aggressive liquidity injections and deeper cuts. The USD/CNY trajectory is not a one-way CNY-strength story; instead, Beijing will likely tolerate modest CNY appreciation against the USD to keep the trade-weighted index inside the 95-105 band it has defended since 2017.
• Further, because China’s inflation is likely to remain lower than that of its trading partners, the real competitiveness of Chinese exports seems destined to continue.