The People's Bank of China lowered the one-year loan prime rate by 10 basis points to 3.35 percent at its monthly review, in contrast to the consensus forecast for no change. This rate had been left unchanged since August 2023. The equivalent five-year rate was also lowered by 10 basis points to 3.85 percent after it was cut by 25 basis points in February.

Quarterly data released last week showed weaker GDP growth in the three months to June, with monthly data also showing slower growth in key activity data and a sharper drop in house prices in June. Officials cautioned that"the external environment is intertwined and complex, the domestic effective demand remains insufficient and the foundation for sound economic recovery and growth still needs to be strengthened".

After noting in recent months that they will seek to"frontload and effectively implement" macroeconomic policies that have already been introduced, the statement accompanying last week's data did not contain this language, indicating that some adjustment to policy settings could be considered in the near-term. The reduction in the loan prime rate announced today may provide some support to the property market, with many lenders basing their mortgage rates on the five-year loan prime rate.

Officials are expected to hold rates unchanged at July's announcement: at 3.45 percent for the 1-year rate and 3.95 percent for the 5-year. The last time either of these rates were changed was in February with a 25-basis-point cut for the 5-year.

The one-year Loan Prime Rate is a new policy rate set by the People’s Bank of China that is used by domestic banks as a reference for the lending rates they offer to their most creditworthy clients. This rate was previously based on the official benchmark rate that required the approval of China’s State Council to be changed but is now based on the PBOC’s medium-term lending facility, which can be changed without the State Council’s approval. New bank loans are now priced relative to the Loan Prime Rate.

The People’s Bank of China determines interest rate policy at its policy meetings. These meetings occur on or around the 20th of each month and market participants speculate about the possibility of an interest rate change. The level of interest rates affects the economy. Higher interest rates tend to slow economic activity; lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment. In the consumer sector, few homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels. This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the financial markets, while lower interest rates are bullish.