China Cuts Interest Rates, Lends Support to Floundering Economy

Late last year, the Dow Jones Industrial Average (Dow) and Standard & Poor’s (S&P) 500 rounded off five straight weeks of stock gains by hitting new closing highs. The S&P 500 closed at a new all-time finishing high of 2063.5, while the Dow set a new record by closing at 17,810. One of the reasons behind the exuberance displayed by U.S. stocks was the rally that took place in stock markets around the world, as central bankers from China and Europe reiterated their support for markets and struggling economies abroad.

For the first time in two years, the People’s Bank of China (PBoC) announced a cut in official interest rates. It announced that one year benchmark lending rates would be reduced by 40 basis points to 5.6 percent while one-year deposit rates would be reduced by 25 basis points to 2.75 percent. According to most economists, this rate cut by the PBoC is aimed towards helping China meet its 2014 growth target of 7.5 percent. In case the growth target is not met, it would be the first time in 15 years that China would fail to meet its official goal.

With these announcements, investors the world over, including the U.S., heaved a sigh of relief as it helped to ease their fears of the world’s second largest economy slowing down dramatically. For months, Beijing had been avoiding broad stimulus measures, signalling that it did not consider the Country’s slowing growth as a cause of concern. Even as China’s economy showed signs of weakness, the policymakers stuck to limited measures. They made new lines of credit available to certain banks and financial institutions or targeted specific goals like supporting the agriculture industry and constructing subsidized housing. However, those unconventional measures seem to have had limited effect on the economy. Now, the Central Bank has changed its stimulus stance and this action should lift the country’s flagging housing market and large state-owned companies, in turn bolstering other nations that have come to rely on those core parts of China’s economy.

The PBoC rate cut came hours after the Central Bank pumped 50 billion Yuan into the short term money markets to ensure that liquidity remained available in the domestic financial markets. The PBoC also revealed that commercial banks will now be allowed to set deposit rates 1.2 times above the official benchmark rate, compared to 1.1 times previously. Although the Central Bank proclaimed in a statement that it feels no need to undertake strong stimulus measures, and that the prudent monetary policy direction will not change, these new measures seem to indicate that further financial liberation is underway.

The fact that China has finally admitted it has a growth problem is a big step towards setting the global economy back on track. By cutting rates, China joins the ranks of global policymakers who have stepped up their stimulus efforts to support growth and encourage worldwide spending.