China's economic difficulties have led to the largest interest rate cut since 2020

China's central bank unexpectedly lowered key policy rates for the second time in three months on Tuesday, a further indication that authorities are intensifying monetary easing efforts to stimulate a sputtering economic recovery.

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The action, according to analysts, paves the way for a possible cut in China's lending benchmark loan prime rate (LPR) next week.

According to market observers, the decline in credit expansion and the increasing likelihood of deflation in July have prompted the need for additional monetary easing measures to counteract the economic downturn. Furthermore, concerns regarding potential defaults among certain housing developers and the failure of a private wealth manager to make timely payments have also had a detrimental impact on confidence within the financial markets.

According to Tommy Wu, a senior China economist at Commerzbank, the aforementioned factors contribute to the pressing need for policymakers to take prompt action before a significant decline in consumer and business confidence occurs.

The People's Bank of China (PBOC) has announced a reduction in the interest rate for one-year medium-term lending facility (MLF) loans to certain financial institutions. The rate has been cut by 15 basis points, from 2.65% to 2.50%, for a total value of 401 billion yuan ($55.25 billion).

According to an online statement by the People's Bank of China (PBOC), the purpose of the cash injection was to mitigate various circumstances, such as tax payments, with the aim of maintaining a relatively abundant level of liquidity in the banking system.

According to a recent survey conducted by Reuters, 77% of the 26 market analysts polled projected that the central bank would maintain the MLF rate without any changes. A mere six participants predicted a decrease in the marginal rate.

According to Ken Cheung, the chief Asian FX analyst at Mizuho Bank, the unexpected reduction in interest rates was a swift measure taken to boost the weakened credit statistics and potential economic rebound in China, which might potentially lead to a depreciation of the yuan towards the level of 7.3.

The People's Bank of China (PBOC) may have the intention to provide assistance for medium-term credit conditions by an asymmetric reduction. This move could potentially pave the way for a reduction in the Loan Prime Rate (LPR), notably the 5-year LPR, with the aim of assisting the property industry, which is currently facing challenges.

The MLF rate functions as a reference for the LPR, and financial markets typically rely on the medium-term policy rate as an indicator for potential adjustments to lending benchmarks. The monthly adjustment of the Loan Prime Rate (LPR) is scheduled for the upcoming Monday.

According to an online statement, the central bank implemented a measure of injecting 204 billion yuan through seven-day reverse repos, while simultaneously reducing borrowing prices by 10 basis points from 1.90% to 1.80%.

China stands out from other global central banks due to its decision to implement a more relaxed monetary policy in order to support an economy that is experiencing a slowdown, in contrast to other central banks that are now engaged in tightening cycles as a means to combat high levels of inflation.