In a surprising move, the Chinese central bank keeps interest rates unchanged

In a surprise move, China's central bank left its key interest rate unchanged on Monday as it continued to pump more money into the financial system.

The People's Bank of China decided to hold the interest rate on its one-year loans - called the medium-term lending facility (MLF) - at 2.5 percent, contrary to widespread expectations among economists that it would make the first rate cut since August to support the economy.

However, the Chinese central bank also provided 995 billion yuan (about $139 billion) in liquidity to banks through medium-term lending facilities, bringing the net provision to banks of 216 billion yuan to enhance liquidity and help meet demand for financing.

In this regard, Frederick Neumann, chief Asian economist at HSBC Bank, said: The bank’s decision not to reduce interest on loans for one year indicates that there is not much urgency regarding adding more stimulus to the Chinese economy, according to Bloomberg.

However, some market watchers said that narrowing interest rate spreads at commercial banks and a weak Chinese yuan have limited room for the People's Bank of China to maneuver, and interest rate cuts may be delayed until later this year.

China's economy continues to face challenges, with recent economic data pointing to an uneven economic recovery, with exports rebounding in December but credit growth remaining weak and deflationary pressures persisting.

Economic analysts at Capital Economics believe that the main reason behind the central bank’s retreat from cutting interest rates is to avoid increasing pressure on the yuan and causing its decline.

The Chinese yuan has already weakened more than 1 percent against the dollar since the beginning of the year, reaching its lowest level in more than a month due to uncertainty about when the US Federal Reserve will start cutting interest rates.

Although there are no rate cuts currently, Capital Economics still expects two cuts of 10 basis points by the end of the second quarter, in addition to a reduction in the required reserve ratio (RRR).

The Chinese central bank said in an online statement that Monday's lending operation was aimed at fully meeting cash demand at financial institutions to maintain reasonably sufficient liquidity in the banking system. Which means that the central bank is still keen to support lending and spending activity in the economy.

In a Reuters poll last week, 19 out of 35 market participants expected the central bank to cut the interest rate on one-year loans to help support the weak economy.

The vast majority of participants also expected the People's Bank of China to inject new liquidity into the financial system beyond the outstanding amount.

These expectations increased after major Chinese commercial banks cut interest rates on their deposits late last year, and after recent disappointing economic data reinforced the view that further stimulus is warranted.

Economists at ANZ said the People's Bank of China may have held off on cutting interest rates because authorities may be concerned about banks' profitability.

With interest rates holding steady over the medium term, some market observers now expect a decline in banks' reserve requirements to release new funds to boost credit and growth.

“We continue to see quantitative and liquidity measures as the main focus of policy,” said Frances Cheung, interest rate analyst at OCBC Bank.

With the decision made by the People's Bank of China this morning, market expectations for reducing the required reserve ratio will remain high, Cheung said.

Investors' expectations for a reduction in reserve requirements came after Zhou Lan, head of the Monetary Policy Department at the People's Bank of China, highlighted the reserve requirement ratio as a monetary policy option to support credit growth, according to a state media report last week.

Seasonal factors could also delay monetary easing, as financial institutions typically have to assess their profitability and their clients' appetite for loans for 2024 before the Lunar New Year holiday, which begins on February 10, said Marco Sun, senior financial markets analyst at MUFG.

MUFG maintained its forecast of a 20 basis point interest rate cut at the People's Bank of China later in 2024.

Data due this week on industrial production, investment and retail sales for December, along with fourth-quarter GDP, will give investors clues as to whether the economy will need further support.