China:Our multi-asset view on the targeted RRR cuts

Following the State Council meeting on 27 September, the PBoC announced targetedRequired Reserves Ratio cuts on 30 September. Eligible loans cover micro companies,self-owned businesses, and agricultural sector, start-up, poverty and educationassistance loans. Banks with 1.5% of either outstanding loan or new lending (2017annual) in the eligible area will receive a 0.5ppt reduction in RRR. According to the PBoC,this covers all mid-large banks, 90% of city commercial banks and 95% non-county levelrural co-operative banks. On this basis, it could release up to RMB800bn liquidity.

    Those with eligible loan at 10% (outstanding or new lending) will receive a further 1pptreduction. Both reductions are effective from 2018.

    We do not think the RRR cuts represent a meaningful change in monetary policy stance.

    Although activity data slowed in July and August, these reflected temporary or policydrivendisruptions to output caused by bad weather, environmental regulations andcapacity rationalisations. Indicators like the PMIs suggest that the manufacturing recoveryshould still support demand in the near term.

    The main motivation is liquidity-related. In recent years, although the trend in FXreserve accumulation had reversed, the PBoC had refrained from RRR cuts toneutralise the impact, in order to avoid fuelling outflow expectations. Instead it reliedon open market operations. As a result, excess reserves have declined and liquidityhas become more short-dated in nature. The latest policy move is a reminder that anRRR cut remains a viable option for the purpose of liquidity management.

    As RRR cuts are more broad-based and less discriminating than open marketoperations, they can reduce concerns of excessive liquidity tightness amongst smallbanks and non-bank financial institutions, particularly when the amended Macro-Prudential Assessment Framework takes effect in 2018.

    Rates Strategy: Over the remaining three months of the year, money market rates inChina are still biased higher although any severe cash crunch is unlikely. We remainbearish on China bonds.

    FX: One-way RMB depreciation is over and USD-RMB is in the new norm of two-wayflexibility. We recommend selling EUR-CNH.