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The 1-year Loan Prime Rate (LPR) was kept unchanged at 3.10% earlier this week amid a stabilizing growth momentum. The central bank is waiting for the effect of previous stimulus and easing measures to unfold before implementing another round of cuts. The GDP growth in Q4 2024 accelerated to 5.4% YoY from 4.6% YoY in Q3 2024. We believe the room for 1-year LPR cuts is trimmed from 50bps to 30bps in 2025, with year-end rate reaching 2.80%. (see: China achieved 5% growth in ‘24; could ’25 be the same?).
The primary concern is the elevated USD rates. The resilient US economy, as well as potential tariffs, are adding upward pressure on the dollar rates and weighing on the CNY exchange rates. The spread between the 10Y UST and CGB has already compressed to around -300bps, with the USD/CNH exchange rate heading towards 7.30 again. This will continue to constrain how far the People's Bank of China (PBOC) can cut, given its priority of managing exchange rate stability.
Domestically, a delayed rate cut would help prevent further squeeze on banks' net interest margins (NIM). The NIM has already fallen to a historical low of 1.53% as of the third quarter of 2024. Against this backdrop, Beijing is expected to favor liquidity injection over aggressive rate cuts. Over the past three weeks on entering 2025, the PBOC has already injected CNY 3,096 billion into the system via reverse repo agreements. The injected amounts on January 15 and January 22 hit the second and third highest levels on record, respectively. There will be another 100bps reserve requirement ratio (RRR) cut this year to release CNY 2 trillion of liquidity. Meanwhile, the central bank will likely restart its government bond purchasing program soon. Note that its claims on the government only reach 2.1% of GDP as of December, compared to the 6.0% last seen during the Global Financial Crisis in 2008.
Strategy-wise, the downside risk on CGB yields will be limited by the slower pace of rate cuts. The 2Y and 10Y CGB yields are expected to find their footing at 1.05% and 1.50%, respectively. In terms of the curve, a slower pace of rate cuts will likely lead to a flattening curve.
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