China Gives Bank of England Rate-Setters Food for Thought

The People’s Bank of China reformed the exchange rate formation system on August 11 to better reflect market development in the exchange rate of the Chinese yuan against the US dollar.

The People’s Bank of China announced on its website that it was reducing lending and deposit interest rates by 0.25 percentage points each and its reserve requirement ratio by 0.50 percentage points.

This week’s market turmoil, and the signals it sends about the health of the global economy, will give officials at the Bank of England fresh food for thought when they meet to discuss policy next month. Lending rates in the U.S., Europe and Japan already are close to zero and the rout is shaking confidence that the global economy will be strong enough to withstand an expected policy tightening by the Federal Reserve.

It’s no secret that China’s economy has been slowing and its stock market has been staggering since June.

Various other factors are contributing to the market turbulence, including the speculation over a U.S. interest rate hike that could result in the pullout of funds from currency and stock markets in emerging economies. Chinese stocks plunged the most since 2007.

Given volatility in global financial markets, “we need to use monetary policy tools more flexibly”, it said.

“Speculators are selling assets that seem the most vulnerable”. The Shanghai Composite index fell 7.6 per cent on Tuesday, deepening the 8.5 per cent loss sustained on Monday.

The central bank’s move was broadly welcomed by economists.

China’s central bank on Tuesday warned that “economic growth rate remains under pressure”, adding the cuts were meant in part to “support the real economy to continue to develop healthily”.

“It is not the role of the central bank to elevate sentiments unduly, to deliver booster shots to the stock market so that it can soar for a while, only to collapse when reality hits”, he told a conference in Mumbai on Monday.

Shanghai shares see-sawed in early trade Wednesday, after Beijing’s move to cut interest rates and free up cash for banks failed to restore confidence in China’s growth and arrest the crisis that has rattled global markets.

Policy makers’ efforts to underpin growth have yet to avert the slowdown, threatening Premier Li Keqiang’s expansion target of about 7 per cent for this year.

Friday, one measure of Chinese manufacturing dropped to its lowest level in more than six years.

Even if the slowdown in China doesn’t dent British growth too much, its effects may be felt in inflation.

-With assistance from Kevin Hamlin in Beijing.