Near the closing time on July 9, the people's Bank of China announced that it would cut the deposit reserve ratio of financial institutions by 0.5 percentage points on July 15, 2021, after the executive working meeting of the State Council on July 7 issued a signal to reduce the deposit reserve ratio. It is estimated that the move will release about 1 trillion yuan.

Against the backdrop of rising commodity prices this year and increasing pressure on house prices in major cities at the beginning of the year, what kind of policy signals did the central bank cut its reserve requirements? What will be the impact on the stock market, property market, commodity market and so on? What will be the trend of monetary policy in the second half of the year? In this regard, Bank of China Securities Global Chief Economist Guan Tao expressed his views.

Guan Tao believes that the across-the-board RRR cut is a routine operation after the return of monetary policy to normal, which at least shows that monetary policy will not be as tight as the market expected, and that "reasonable and abundant liquidity" is not a simple written expression; this can play the role of "killing two birds with one stone"-that is, stabilizing market expectations and alleviating the operational difficulties of small and medium-sized enterprises. But he doesn't see it as the start of a new easing cycle.

Guan Tao also pointed out that in view of the slow recovery of China's consumption, it is a challenge for policy to link up with domestic demand if external demand weakens. Monetary policy alone is not enough to achieve a higher equilibrium of the economy, fiscal policy and industrial policy are indispensable.

The following is the text:

Not the beginning of a new easing cycle.

Atomic think tank: after the signal of the National standing Committee's reserve reduction came out this week, the central bank lowered the reserve requirement quickly, and it was a comprehensive reserve reduction more than a year later. In your opinion, why is it necessary to lower the reserve requirement at this time? What is the purpose of this reduction?

Guan Tao:The across-the-board reserve cut is a routine operation after the return of monetary policy to normal.

The RRR cut may be used to replace maturing medium-term loan facilities (MLF) and keep liquidity reasonably abundant-the amount of MLF maturing in the second half of the year is relatively large, with maturities of 1.7 trillion yuan and 2.45 trillion yuan respectively in the third and fourth quarters, of which 400 billion yuan is due in July, double that in June. The cut may also release some funds to be used by financial institutions to make up for the liquidity gap caused by the peak of the tax season in mid-late July.

The across-the-board RRR cut belongs to the deep thawing of bank liquidity, which helps to increase the long-term funding sources of financial institutions. Through the release of long-term funds, it is expected that the capital cost of financial institutions will be reduced by about 13 billion yuan per year, and then transmitted through financial institutions to reduce the comprehensive financing cost of the society.

At present, the RRR reduction can play the role of "killing two birds with one stone", that is, stabilizing market expectations and alleviating the operational difficulties of small and medium-sized enterprises.

Although China's economy is still in the stage of expansion and repair, some of the momentum of recovery has slowed down. According to a questionnaire survey conducted by the central bank, the enterprise loan demand index dropped sharply by 7 percentage points to 70.5% in the second quarter compared with the first quarter, the lowest since the second quarter of last year, while residents' perception of current income and future employment expectations fell 0.5 and 0.9 percentage points respectively from the first quarter, interrupting the upward trend for four consecutive quarters since the epidemic.

While economic expansion is slowing down, consumption is not as good as imagined, uneven recovery and large increases in raw material prices have had a greater impact on small and medium-sized enterprises. In recent months, the growth rate of consumption has been lower than market expectations, which restricts the transmission of changes in production costs between the production side and the consumer side, and between upstream and downstream enterprises. Since the beginning of this year, the "scissors gap" between CPI and PPI, PPI and PPIRM has continued to expand, reaching 7.7% and 4.3% respectively in June, which is at an all-time high. And small and medium-sized enterprises are concentrated in the middle and lower reaches, the pressure can be imagined. The current RRR cut can not only help enterprises reduce their financial burden, but also release the signal that monetary policy does not make a sharp U-turn and stabilize expectations to a certain extent.

Atomic think tank: estimates show that the cut is expected to release long-term funds of about 1 trillion yuan. Is this scale in line with your expectations? Why?

Guan Tao:The scale is about the same as we expected. From the perspective of the last two comprehensive reserve cuts, the central bank released 800 billion yuan in September 2019 and January 2020. This across-the-board reserve reduction will not be less than 800 billion yuan, mainly because the deposit base involved in the reduction is on the rise. At present, the liabilities of broad money included in the balance sheets of financial institutions are about 190 trillion, which is relatively close to the deposits involved in the RRR reduction. A 0.5% RRR reduction is equivalent to 950 billion yuan in basic liquidity, which is not much different from the 1 trillion yuan announced by the central bank.

Atomic think tank: can you explain the inflation rate cut?

Guan Tao:The market has always been controversial about the price stability goal of monetary policy, that is, whether to mainly look at PPI or CPI?

The major central banks in the world all look at consumer prices, but China, as a big producer, PPI is considered by many market participants to be more important. In the past, PPI year-on-year growth rate increased the transmission of CPI growth rate is relatively strong, so the two together, there may not be a big difference. However, PPI is a global variable, which is easily affected by overseas uncontrollable factors, and sometimes can not accurately reflect the real consumption and price situation of our country.

If you look at China's CPI and core CPI, the current year-on-year growth rate matches the lack of consumption. Year-on-year CPI growth in June fell 0.2 percentage points from the previous month to 1.1 per cent, while core CPI was unchanged at 0.9 per cent from the previous month. Core CPI turned negative again after a lapse of six months, and service prices also fell month-on-month.

Generally speaking, the PPI increase of structural inflation is relatively high, which is not caused by overheated domestic demand, but belongs to the imported inflation caused by the rise in international commodity prices, so it is difficult for domestic monetary policy to make a difference.On the other hand, if the RRR cut can stimulate the rise in aggregate demand and lead to a proper rebound in CPI, thereby reducing the "scissors gap" between PPI and CPI, it may still be a good thing to consolidate the momentum of steady and good development of China's economy.

Atomic think tank: does this cut mean that the easing cycle is coming?

Guan Tao:As we mentioned in a number of reports in the second half of last year, cross-cyclical adjustment is not a simple countercyclical adjustment thinking, but a long-term top-level design. From the perspective of social integration and M2 growth, monetary policy is neither absolutely tight nor overall loose. The central question behind it is whether the long-term trend of China's economy has stabilized.

The impact of this epidemic on China's economy is enormous, and some new problems may arise: for example, the recovery among different industries, departments and enterprises is divided, that is, the so-called K-type recovery. Some of the problems that led to the continuous decline of China's economy before the epidemic may still exist and can only be solved through multi-faceted reforms. Therefore, it is different from the short-sightedness of the capital market (for example, to judge the monetary policy position by focusing on the central bank's daily and monthly open market launch).We do not think this is the beginning of a new easing cycle, and the current monetary policy is more pre-adjusted to match changes in the economic situation.

The RRR cut at least shows that monetary policy is not as tight as the market expected.

Atomic think tank: a reserve cut is usually a big boon for the stock market. what do you expect? Are we going to have a new bull market? This cut will be the most direct positive for which plates?

Guan Tao:The economy and the stock market can interpret the RRR reduction in many ways, both good and bad. If the market believes that the central bank cut the reserve requirements, it may be to make the heat of the economic recovery more lasting, which could be a boon to the capital markets. Conversely, if the market believes that the move means that the central bank may see more risks that the market does not see, it could be negative for the capital markets.

At present, the domestic economic and financial data do not see a clear inflection point, the interpretation of the market may switch back and forth. In the end, the stock market will determine the path by combining the economy, interest rates, the performance of listed companies and the expectations of most people.The cut at least shows that monetary policy will not be as tight as the market expected, and "reasonable and abundant liquidity" is not a simple word.

Atomic think tank: money is always more willing to flow into more profitable places. To what extent do you think this cut will have an impact on the housing market?

Guan Tao:Investment is driven by expectations, buying up or down. Under the background of the "three red lines", cracking down on the illegal inflow of operating loans into real estate and other regulatory policies have been introduced and the principle of not speculating in housing has not been loosened, the market generally expects the real estate boom to decline soon. When house prices lose their upward momentum, the enthusiasm for real estate investment will decline.

In the past, lower reserve requirements have boosted the willingness of financial institutions to lend, and demand for home loans has also risen. However, at present, under the condition that the attitude of regulators towards the property market has not changed, financial institutions still need to arrange loans in accordance with macro-prudential assessment. Financial data released by the central bank showed that medium-and long-term loans to residents decreased by 236yuan and 119.3 billion yuan in May and June compared with the same period last year, indicating that the real estate regulatory policy has initially taken effect.

Atomic think tank: the rise in commodities is often a sign of economic improvement, logically speaking, it should be tightening money. Why should the central bank maintain a loose money side or even cut reserve requirements this time?

Guan Tao:One of the main reasons for the surge in commodity prices is that the recovery of global aggregate supply lags significantly behind aggregate demand in the face of inelastic supply.

Before the outbreak of COVID-19, global manufacturing investment remained in the doldrums for many years and capacity expansion was insufficient to support a rapid rebound in short-term demand. After the outbreak, overseas countries are less efficient in resuming work and production, but there is no significant decline in government-subsidized consumption, and there are even signs of overheating in the United States. Emerging markets are the main body of commodity exports, and many of them have been plagued by the spread of the COVID-19 epidemic, and economic restart has been repeatedly delayed. At the same time, China has experienced supply-side reform and capacity removal, coupled with the restriction of environmental protection, the phenomenon of "rising prices and removing inventory" has appeared in China, that is, in the case of rising prices of raw materials, the growth rate of product inventory of upstream mining enterprises is declining compared with the same period last year, and the production enthusiasm is slightly insufficient. For example, domestic steel prices continued to rise from January to May amid a slowdown in infrastructure.

Monetary policy is difficult to control the inflationary pressure on the supply side, while the large rise in commodities may have affected the normal operation of enterprises in the middle and lower reaches-small and medium-sized enterprises are mainly concentrated in the middle and lower reaches. Central bank reserve reduction can reduce the cost of financial capital, through the transmission of financial institutions, promote the reduction of social financing costs (including bond financing costs driven by the decline in the yield of treasury bonds), and alleviate the financial pressure of small and medium-sized enterprises to a certain extent.

Atomic think tank: it has been commented that this policy has reduced market concerns about monetary policy tightening, but raised market concerns about the economic downturn. What do you think?

Guan Tao:Monetary policy and economic operation are endogenous to each other, and there is a dynamic balance between them.At present, the main economic indicators are still in the process of returning to the mean or normal.Previously, due to the high year-on-year growth of PPI and strong economic indicators, the market once predicted that monetary policy would be tightened. After the central bank cut the reserve requirement, the market expectation immediately changed 180 degrees, and the economy jumped from recovery to stagflation and downward, indicating that the market is judging policies on the basis of the economy. As soon as the policy changes, it demonstrates the economic situation circularly, and lacks a rigorous demonstration based on economic laws.

However, as early as April 30, the meeting of the political Bureau of the CPC Central Committee made it clear that the economy should achieve a higher level of equilibrium in the recovery.The central bank's monetary policy adjustment may also be aimed at further unlocking economic potential rather than realising that the economy is turning downwards.Just as the Fed maintains loose monetary policy, it does not think that the current US economic situation is bad (the interest rate meeting in June also sharply raised the forecast for US economic growth this year), but to support a fuller recovery. to promote widespread and inclusive employment.

The impact of the epidemic on China's economy is still there, with the economy showing that external demand is stronger than domestic demand and service industry is weaker than industry. It remains to be seen whether the economic normality has changed after the impact of the epidemic (the growth rate of some economic indicators may have gone down a step). In addition, indicators of economic sentiment have slowed somewhat. In June, the manufacturing PMI index fell for the third month in a row, down 1 percentage point from March to 50.9%, while the index of new export orders also fell into a depressed range.In view of the slow recovery of consumption in China, it is a challenge for policy to link up with domestic demand if external demand weakens. Monetary policy alone is not enough to achieve a higher equilibrium of the economy, fiscal policy and industrial policy are indispensable.

Atomic think tank: the market is concerned about when the Fed's easing policy will turn? What kind of disturbance will this cause to China's financial market? How to look forward to the monetary policy in the second half of the year?

Guan Tao:Recently, some Fed officials have made it clear that they are willing to cut back on bond purchases and raise interest rates ahead of time. In June, the FOMC bitmap showed the expectation of raising interest rates in 2023 for the first time, and seven people supported an interest rate hike in 2022. It's just that, so far, the Fed is not ahead of the curve. A survey of market participants by the New York Fed in April showed that the US market is expected to raise interest rates around mid-2023 and begin to scale back bond purchases in the first quarter of next year.

Many domestic institutions also believe that the Federal Reserve may formally signal a reduction in bond purchases at the Jackson Hole meeting in August and the FOMC meeting in September. But the minutes of the June FOMC meeting show that there are internal disagreements over how to scale back: whether to reduce purchases of mortgage-backed securities (MBS) first, or proportionally reduce purchases of Treasurys and MBS? The Fed may also have yet to agree on how quickly to scale back its bond purchases. If the Fed's turn continues to lag behind the curve, the probability of sudden tightening of monetary conditions will not be too high.

At present, the Fed's policy shift is likely to be transmitted domestically through exchange rates and sentiment. However, the wide interest rate gap between China and the United States, the increase in the flexibility of the RMB exchange rate and the substantial improvement in the mismatch of private currencies have all provided a solid foundation for China's monetary policy. In our research report at the end of last year, we pointed out that adhering to the normal monetary policy is not equal to the interest rate, the deposit reserve ratio and the balance sheet.In the second half of this year, the market is likely to be divided over whether the economy is out of the downward channel, debating whether to maintain economic growth.In view of the fact that China's economy needs a more comprehensive recovery in the second half of the year, monetary policy should not only continue to use structural policy tools to accurately "drip irrigation", but also use aggregate tools appropriately and timely to improve the transmission efficiency of monetary policy. guide interest rates in the bond market to lower and promote the development of direct financing.