Wednesday, July 11, 2012

China's central bank will have to cut rates further to avoid hard landing

As China's inflation rate moderates, the real lending rate is rising. In fact the ISI Group is predicting inflation of 1.8% (annualized) within the next couple of months. That would translate into a 4.5% real lending rate - the highest since 2009.

China real 1-year lending rate (red = forecast)

But in 2009 China's economic growth was considerably stronger than it is now, justifying higher real rates. In the current environment however, real rates need to come down in order to avoid a "hard landing" scenario. That means PBoC should aggressively lower policy rate from the current 6% level.

And that's exactly what the rate swap curve is forecasting. Within a week, not only did the SHIBOR swap curve move down considerably, but it also became more inverted, pointing to further PBoC easing.

China's interest rate swap curve
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