China has been increasing the pace of its monetary easing. On 10 May, the People’s Bank of China (PBoC) cut both the benchmark lending and deposit policy rate by 25bps. This decision came just a few weeks after the PBoC had cut the reserve requirement ratio (RRR2) for banks by 100bps to 18.5%, effective from 20 April.The RRR cut was the largest since November 2008, when it was lowered by 125bps. HSBC’s chief China economist Qu Hongbin estimates that this will release about RMB1.2trn of liquidity into the system. Looser liquidity conditions are necessary before lower policy rates can be passed on to borrowers to support growth and alleviate indebtedness. HSBC expects a further 25bp cut to the policy rate and a 100bp cut in the RRR in 2015. But looser monetary policy does not necessarily feed into a much weaker RMB. China’s capital account is still more closed than others, and hence the transmission of lower interest rates is not as direct as it may be for other currencies. Indeed, should investor sentiment improve with better economic growth prospects, it may actually support the RMB and offset the impact of reduced carry. This has been the case so far, with USD-CNH falling in 2015 despite the decline in onshore interest rates.
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