The extent of the cut this time is more "restrained". On April 15, the central bank announced an across-the-board 25bp cut, reducing the 25bp of some city commercial banks and agricultural commercial banks, releasing a total of 530 billion yuan, significantly less than the 1.2 trillion yuan of liquidity released by the reserve cut at the end of last year. This is the first time in the history of the central bank to reduce the extent of 25bp.

The rate of reduction is relatively restrained, and we think the main reasons include the following two points:

First, structural monetary policy has intensified, other channels are also providing liquidity, and a sharp cut in reserve requirements is not urgent.The intensity of the structural monetary policy may be significantly increased this year. 100 billion yuan of small re-loans for supporting agriculture have been allocated in the first quarter, and the two new re-loan lines have also reached 240 billion yuan, and there is still room to increase the amount of small re-loans for supporting agriculture. This year, there may be an accumulative increase of 5000-700 billion yuan in re-loans. In addition to the structural monetary policy, the central bank handed over profits of about 1 trillion yuan this year, and at the end of last year, the central bank lowered the reserve requirement and released 1.2 trillion yuan, part of which was used to replace MLF, with a net investment of 750 billion yuan. In addition to the above channels, the net investment of MLF from January to April this year is 400 billion yuan. Taken together, the above channels provide banks with liquidity of about 2.75 trillion yuan. Assuming that deposits increase by 20 to 21 trillion yuan this year, banks will need to pay about 1.7 trillion yuan more in reserves. The liquidity provided by various channels can basically meet the banks' demand for long-end liquidity, and the urgency of a sharp cut in reserve requirements is not strong.

Second, avoid excessive signal effects to disturb the exchange rate.The rapid narrowing of the interest rate gap between China and the United States has brought the pressure of capital outflow. at present, if the monetary easing operation with excessive signal effect is carried out, it is likely to further aggravate the pressure of capital outflow. At present, the central bank may give priority to monetary policy operations with weaker signal effect but stronger actual effect to achieve the goal of stable growth.

In addition, the reduction of MLF maturity and the low deposit reserve ratio will also affect the central bank's decision-making to a certain extent.

The central bank has two options to cut reserve requirements, one is to replace part of the MLF, the other is not to replace the MLF, directly release liquidity. But after the cut, the required reserve ratio has fallen to 8.1%. The central bank proposed in 2020, "judging from the history of our country and the situation of developing countries, the required reserve ratio of 6% is a relatively low level."[1]At the same time, the central bank has stopped continuing to cut the required reserve ratio for institutions whose deposit reserve ratio has fallen to 5%. In addition, there are 5.15 trillion yuan in MLF due in 2021 (700 billion yuan per month in the second half of the year), and 4.55 trillion yuan in MLF due in 2022 (38 billion yuan per month), a decrease of 600 billion yuan compared with the same period last year, which also limits the room for central bank reserve reduction (replacement of MLF) to some extent.

Although the current and 2018 are in the Fed's rate-raising cycle, and the interest rate gap between China and the United States has narrowed significantly in 2018, it is not appropriate to directly compare the current reserve cut with 2018.

First of all, let's review the situation in 2018. The cut in the first half of the year is more aimed at financial markets, and the cut in the second half of the year is more aimed at the economy. The cut before the third quarter of 2018 was not aimed at the economy, but more at the liquidity shortage in the financial markets at that time. China's economy did not weaken significantly in the first half of 2018, and it was also an acceleration period of financial deleveraging. Interbank certificates of deposit were incorporated into interbank liability management for the first time, subject to the restriction that interbank liabilities could not exceed 1/3 of total liabilities, and the pressure on banks' liabilities increased sharply. The return of a large number of off-balance sheet assets further increased the liquidity pressure of banks, and the three-month SHIBOR was in a very high position, so the central bank announced a targeted reduction in June. After entering the third quarter, the economic fundamentals gradually weakened, and the revenue and profit growth rate of industrial enterprises gradually declined, so the central bank began to cut reserve requirements continuously from the third quarter to the beginning of 2019. As the exchange rate was also faced with greater depreciation pressure at that time, the central bank chose to cut reserve requirements instead of interest rates, taking into account the internal and external balance. It was not until the federal funds rate began to decline in July 2019 that we started the LPR reform (LPR cut 11bp twice in August and September 2019 to merge the MLF interest rate), and then cut the MLF benchmark interest rate.

There are several obvious differences between the current situation and 2018. First, the current economic fundamentals are under greater pressure than in the second half of 2018, and there is still great uncertainty about the development of the epidemic. Therefore, the difficulty and urgency of steady growth at present is much higher than that in the second half of 2018. Second, the weighted reserve ratio of financial institutions at the beginning of 2018 was 14.9%. Now it is 8.1%, 6.8 percentage points lower. Third, the liquidity pressure within the financial market itself is not great, and the short-end interest rate is relatively stable. Fourth, the Fed is also tightening faster than in 2018. If the US raises interest rates about eight times a year and the range of the federal funds rate reaches 2.0% Mel 2.25%, the short-term capital spreads between China and the United States may be upside down.

Looking forward, the central bank's monetary policy attitude is "self-oriented, internal and external balance", which not only requires the coordination of fiscal policy, we expect the central bank to cut interest rates in a more flexible way.

Under the background that inflation and exchange rate have not yet formed substantive constraints, stable growth is still the primary goal of monetary policy, but taking into account internal and external balance requires more policy coordination. Specifically,

First, the reduction of reserve requirements needs to rely on the joint efforts of fiscal policy to form the actual effect of stable growth. The introduction of fiscal policy and the support of re-lending policy can stimulate credit demand, support market interest rates, and take into account external balance while stabilizing growth.

Second, central banks can flexibly influence interest rates in ways that are less signalling but have practical effects. For example, banks can cut the difference between interest rates and benchmark rates on their own. For example, banks in more than 100 cities have cut mortgage rates by 20-60bp since March. In addition, we can further promote the reform of deposit interest rate pricing mechanism to reduce the deposit cost of banks, so as to further promote the reduction of loan interest rates.

Figure 1: unlike in 2018, the current liquidity in financial markets is not tight.

Chart 2: China's economy is facing more challenges today than in 2018.