Source: Brokerage China Author: He Jueyuan

In June, there was still 237 billion yuan of MLF due, so the central bank achieved a reduction in quantity and price by continuing the MLF for the same amount, and net withdrew 55 billion yuan through MLF. This is also the central bank's choice to reduce the amount of MLF after reducing the amount in March and April.

Some experts believe that from the perspective of "quantity", the current liquidity is reasonable and abundant, and the demand for banks to "fill up" with the central bank is relatively low. The central bank's reduction in quantity and continuation of MLF may be aimed at avoiding the idling of funds. From the perspective of "price", the current lower MLF interest rate is constrained by factors such as bank net interest margin and RMB exchange rate. As the impact of measures to deal with the financial crisis gradually decreases, the central bank's policy space to implement reserve reduction and interest rate reduction in the second half of the year will gradually open up.

The central bank once again continued the MLF for a reduced amount.

Since June, liquidity in the banking system has been maintained reasonably abundant, and market interest rates have remained stable. The weighted average interest rate of the 7-day pledge repo rate in the interbank market (DR007) has fluctuated around the 7-day reverse repo rate, with a fluctuation range of 1.77% to 1.81%.

Experts believe that the central bank's choice to reduce the amount of MLF again in June reflects the recent abundant liquidity in the banking system, and the central bank does not need to increase the supply of medium- and long-term liquidity.

In fact, the scale of funds that the central bank has net withdrawn through MLF three times this year is not large, and the monthly net withdrawn funds are all less than 100 billion yuan. Wang Qing, chief macro analyst at Dongfang Jincheng, told Securities Times that the recent MLF operations are generally in a state of reduction or the same amount of continuation, behind which is that the pace of bank credit has slowed down and the liquidity of the banking system is relatively abundant. "This does not mean that there is a signal of shrinking quantity on the policy side."

Some experts also believe that the low intensity of MLF operations and the yield of interbank certificates of deposit reflect the central bank's efforts to avoid excess supply of money, leading to some funds being idle. This year's government work report explicitly stated that it is necessary to "prevent funds from being idle", and the recent continuous standardization of "manual interest supplementation" in the banking industry is precisely to limit the opportunity for large enterprises to engage in the idle arbitrage of "low loans and high deposits", and to transfer spare funds that were originally used for arbitrage.

Since mid-April, the yield of 1-year interbank certificates of deposit issued by commercial banks (AAA) has been hovering between 2.0% and 2.1%, maintaining a narrow range of volatility, and the interest rate differential between them and MLF has remained at a high level. Industrial Securities research report believes that after the prohibition of "manual interest supplementation" in April, the pressure on the liability side of banks' balance sheet has increased, which has led to major state-owned banks actively managing liabilities through the issuance of 1-year interbank certificates of deposit. Therefore, the overall supply pressure is relatively large.

With the gradual weakening of the impact of financial deleveraging and the increase in government bond issuances since May, market experts believe that the demand for medium- and long-term liquidity by banks will increase, and MLF will be expected to shift to excess continuation.

"Dual Constraints" Keep MLF Interest Rates Unchanged

Since the beginning of this year, the central bank has repeatedly stated publicly that there is still room for monetary policy, but the effect of previous policies is still showing, and further interest rate cuts at this stage are constrained by internal and external "dual constraints" from net interest margins of banks and RMB exchange rates. Therefore, the market experts expected the MLF interest rate to remain unchanged in June.

As of the end of the first quarter of 2024, China's commercial banks' net interest margin further fell 15 basis points to 1.54% from the end of last year, at a historical low. Zhang Xu, chief fixed-income analyst at China Everbright Bank, said in an interview with Securities Times that a reduction in MLF interest rates at this time would bring greater pressure to net interest margins, which would not only affect the sustainability of financial support to the real economy, but also create space for idle funds and "low loan and high deposit" arbitrage.

With the standardization of "manual interest supplementation" in the banking industry, the previously "overstated" deposit interest rates will return to normal, which is equivalent to the decline in bank deposit liability costs. Considering the factors of re-pricing after the expiration of existing deposits, industry insiders pointed out that the effect of the previous downward trend in deposit rates will continue to appear.

The continued pressure on RMB exchange rates is also constraining the central bank's monetary policy. At present, the interest rate differential between China and the United States has reached 220 basis points, and it is not easy for the RMB exchange rate against the US dollar to remain around 7.2. Despite the recent rate cut by the European Central Bank, Wen Bin, chief economist at Minsheng Bank, told reporters that the timing of the Fed's rate cut is still uncertain, and even if it is cut, high interest rates will still be maintained for a long time. "Under this background, the restraint of overseas monetary policies on domestic easing remains relatively large."

Experts: There is room for reserve reduction and interest rate reduction in the second half of the year.

Maintaining MLF interest rates means there is no downward pressure on the loan market quote rate (LPR) in June. However, as internal and external constraints gradually ease, experts surveyed unanimously believe that the necessity of using overall monetary policy tools to boost domestic demand and promote mild inflation still exists. As internal and external constraints gradually ease, the pace of monetary easing in the second half of the year may accelerate, and there is room for both deposit and interest rate cuts.

The key to whether interest rates will be lowered or not lies in whether the deposit and loan benchmark interest rates will be adjusted. Wang Qing believes that in the future, the degree of policy rate cuts will be limited. The priority combination of policy tools will be to keep the MLF operating rate unchanged and push the LPR quote down by guiding the deposit rate downward and implementing comprehensive reserve requirements reduction, thereby reducing various types of loans, especially the interest rates for residential mortgages, and easing the situation of high actual interest rates.

One key objective of lowering MLF interest rates is to guide the LPR down. Once the LPR drops on its own, the necessity of reducing MLF interest rates will also be reduced considerably. Zhang Xu said that after the banking industry standardizes "manual interest supplementing" to lower bank debt costs and shrink the deposit-loan interest rate gap, the probability of reserve requirement ratio (RRR) cuts in the next two or three months is not low. LPR may subsequently decrease by compressing in increments.

Wen Bin expects that in order to lower financing costs and maintain stable net interest margins for banks, deposit rates still need to be further reduced, which may happen as early as mid-year to the third quarter, thereby creating space for the LPR to be lowered.

Editor/Lambor