China: Tackling a trilemma – Standard Chartered

The PBoC faces difficult trade-offs among growth, currency and financial stability goals. Growth appears to be the priority near-term; we see more RRR and rate cuts in the pipeline. Pressure on CNY may rise in case of a renewed trade war, despite recent respite on Fed cut expectations. Interventions in the CGB market are likely to give way to prudential measures to curb financial risks, Standard Chartered economists Shuang Ding and Hunter Chan note.

Limited scope for CNY depreciation

“The People’s Bank of China (PBoC) has multiple goals and when these goals conflict with each other, the central bank has to prioritise some while keeping deviation of the other goals within tolerable ranges. Following the surprise rate cut in July, we expect more monetary easing in the near future, together with faster fiscal spending and housing destocking, to prevent growth from falling significantly below 5%.”

“While the Chinese yuan (CNY) has recently recovered earlier losses relative to the USD due to expectations of faster Fed rate cuts and narrowing rate differentials, the currency may come under pressure again if Trump wins the November election and implements a 60% tariff on China’s imports. We see limited scope for CNY depreciation in that case, as the benefit of a large devaluation appears elusive while capital outflow risk is likely to be instantaneous.”

“With long-term central government bond (CGB) yields declining sharply, the PBoC has become increasingly concerned that smaller banks with large CGB exposures could suffer heavy mark-to-market losses when yields rebound. We expect the central bank to shift to prudential measures to address duration mismatches of smaller banks, as direct market interventions are costly and tend to create distortions.”