China may cut rates twice as PMI falls

CHINA could be forced to cut interest rates twice in the new year to offset falling prices and flagging economic activity.

Chinese workers at work at a textile factory in Huaibei.

CHINA could be forced to cut interest rates twice in the new year to offset the growing prospect of falling prices and flagging economic activity to help ensure the nation meets its official growth target this year.

The HSBC official Purchasing Manager’s Index (PMI), published yesterday, showed manufacturing output dropped to 49.6 in December, down from 50 one month earlier.

An index reading below 50 indicates the sector is contracting, rather than expanding, while the number of new orders placed with manufacturers during the month also declined.

The HSBC survey is considered the most reliable reading of manufacturing output because it measures activity at both private and state-owned enterprises, which are renowned for inflating their results.

It also showed that manufacturing sector employment fell for the 14th consecutive month, as firms put in place intensified productivity measures.

HSBC senior economist John Zhu said it was likely the People’s Bank of China could be forced to cut the official cash rate twice within the first six months of 2015 to keep the Chinese economy on track.

The government’s 2015 official growth target will not be published until March, but most economists expect it will be set at 7 per cent, down from 7.5 per cent in 2014.

The PBOC delivered a surprise interest rate cut in late November, the first in more than two years, that took lending rates down by 40 basis points to 5.6 per cent and deposit rates by 25 basis points to 2.75 per cent.

Mr Zhu said China’s current rate of inflation, just 1.4 per cent, meant the PBOC had to be wary of deflation emerging as a major problem for the economy this year.

“We know that the PBOC is not a specific inflation-targeting central bank. The government has a target of 3.5 per cent and CPI has averaged 2 per cent,” he said.

“It is on the inflation side where there is the biggest miss. Any other central bank would be paying attention to that and thinking ‘what should we be doing about that’.

“I would argue the PBOC needs to cut rates quickly because we know monetary policy has a long and varied lag effect ... and it is clear that disinflation is not just a short-term trend.

“This risk of leaving a rate cut until later is that those lower inflationary expectations become entrenched.”

HSBC recently cut its 2015 mainland China growth forecast from 7.7 per cent to 7.3 per cent because of weaker economic activity data.

Credit Suisse Private Banking and Wealth predicts the PBOC will cut monetary policy by 40 basis points in the next few months. The bank’s chief investment officer, Cheukwan Fan, said the Chinese central bank was now likely to reduce rates again after the November decision.

“China’s surprise rate cuts indicated a shift in its monetary policy from a neutral stance to an easing bias after the decline in inflation, coupled with the recent strengthening of the yuan against the Japanese yen and Korean won,” he said.

“The likelihood of further policy easing by the PBOC is high if economic data deteriorates further given the persistent weakness in the manufacturing and property sectors.”

Additional reporting Wang Yuanyuan