The unexpected decision by the People’s Bank of China to lower the 7-day reverse repo rate by 10 basis points to 1.7% is notable, as it is the first rate cut since August last year, according to currency strategist Folkmar Baur from Commerzbank.
Positive market response anticipated
China’s unique economic characteristics and strict capital controls make the impact of credit and monetary policy on the currency less significant compared to other currencies. However, the reduction in the benchmark rate still has a meaningful signaling effect.
Initially, expectations for short-term impulses from the recent Third Plenum were low, as the focus was primarily on long-term events and reforms. Although the initial communique was not impressive, the more detailed documents released over the weekend paint a more optimistic picture of constructive reforms, particularly in fiscal policy.
Given the weak growth indicators in the second quarter, the signal of support from the People’s Bank of China is crucial. The upcoming official meeting of the Politburo further raises expectations for additional support measures. Therefore, the market is likely to consider more negative scenarios of a significant growth slowdown, ultimately providing support to the yuan.