Published On: Wed, Nov 11th, 2015

An analytical view on China’s rate cut and how it’s affecting the Forex market trends

forex-marketsSeeing the People’s Bank of China (PBOC) announce a 25 basis point cut in their benchmark lending rate, bringing it down from 4.60 to 4.35% and reducing reserve requirement rations by 50 points was definitely a surprise move. That’s the 6th time they have cut rates since November 2014 and I think they might announce another cut sometime soon.

The goal behind these rate cuts is no brainer. The country is continuously trying to speed up their slow-growth economy. After all, inflation has skyrocketed, export & import activity has tumbled down, its previously escalating stock market has crashed unbelievably and all this has negatively affected its GDP growth, which now is at its weakest ever, since 2009. For a country who was expected to be one of the driving forces behind the Forex trade world, I’d say this is nothing but a nightmare.

Taking the same point forward, let’s not forget that the Chinese economy is the 2nd largest in the world that means what happens in China will most certainly have a ripple effect across the globe.

Let’s put things in perspective to develop a better understanding of what is happening in China and how their series of monetary-easing measures/fixes will impact the Forex market trend.

Chinese Approach- H1

The clearest description for what is currently happening in China is that their old growth model what we know as ‘the fixed investment’ model has most certainly hit its limit and what’s worse is the fact that their next growth model-‘consumption’-isn’t as strong as the first one, which means it can’t replace the previous model completely.

Now, the government is trying hard to manage this slowdown to avoid the economy from coming to a standstill with its series of monetary measures such as fiscal fixes, infrastructure spending and interest rate cuts. Lowering interest rates will also allow home buyers to save more on their mortgage.But will this 0.25 percent be an exciting offer for Chinese companies. Well, not so much, because producer prices are coming down at a yearly rate of almost 6 percent translating into a real interest rate of more than 10 percent. And this directs debt deflation, making companies in China deeply indebted.From what I know, currently, their debt is more than 150 percent of GDP which is among the highest across the globe.So, what I can say is that rate cuts will lead to practically nothing for the country’s long term economic prospects. These cut in rates can be seen as cyclical short-term boosts to the economic train. Nothing more than that!

The Chinese economy is definitely looking for incentives since the last few months. The country’s slow economic activity has created a ripple effect. Many central banks in Asia are now blaming China for creating uncertainty for their economies. So, in my opinion, rates cut in China and monetary easing fixes can bring a bit of relief to other economies. But whether the rapid cut in rates be an effective strategy for China is still a big question mark.

Impact on the Forex Market-H2

The rate cuts by PBoC led to a mixed response in the Forex market. What was expected to shoot up metal prices didn’t really work.Previously, Chinese rate cuts helped commodities prices soarbut it didn’t happen this time. In fact, itfailed to increase metal prices.

But this has not disappointed everyone. Surprisingly, Chinese rate cuts have stirredhope for Australia. The Australian dollar is now regaining ground against its other Forex competitors. It’s believed that stimulus in China could increase demand for Australia’s export of iron ore as currently China accounts for over 40 percent of the global demand for iron ore.

What new measures the Chinese government will take in the future is right now unknown, but I’m sure there are a lot more rate cuts that are yet to come.

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