China cuts interest rates

@CNNMoney June 7, 2012: 11:02 AM ET

NEW YORK (CNNMoney) -- China's central bank announced a rate cut Thursday -- its latest move to try and spur its slowing economy.

In its first rate cut since 2008, the People's Bank of China trimmed a quarter percentage point off its deposit and lending interest rates. China's one-year lending rate is now 6.31%, which is much higher than interest rates in the United States, Europe and Japan.

Economists and investors worldwide are concerned about China's recent slowdown because it is an important driver of global growth. China is now the world's second-largest economy behind the United States.

The central bank had most recently sought to spur growth on May 12 by reducing the amount of cash banks must hold in reserve, an effort to free up funds for lending and investment.

But China's economy has continued to cool over the past month.

A purchasing managers' index compiled for banking company HSBC earlier this month showed that Chinese manufacturing declined in May for the seventh straight month. The index fell to 48.4 in May from 49.3 in April. A reading of above 50 indicates growth in the sector.

Chinese exports have been hit by the European sovereign debt crisis, which has caused 11 countries on the continent to fall into recession and hurt demand from China's largest market.

China's gross domestic product, the broadest measure of its economic health, grew at an 8.1% annual rate in the first quarter. But that was sharply lower than the 8.9% growth at the end of last year.

"We believe that the rate cut will be effective in meeting the short-term objective of getting credit and the economy moving," said Mark Williams, chief Asia economist for Capital Economics. "There could be no stronger signal that policymakers are focused on growth. That alone should prompt more activity by the large state-owned sector."

Given the higher interest rates already in place, China's central bank has much more room to work with to stimulate its economy than its Western counterparts have.

The key interest rate for the Federal Reserve has been near 0% since December 2008. The Fed has made massive asset purchases to try to pump additional cash into the economy since then. Fed Vice Chairman Janet Yellen said Wednesday that the Fed might need to take additional action to stimulate the U.S. economy.

But Fed Chairman Ben Bernanke did little to signal the central bank might provide additional stimulus in his testimony before Congress on Thursday.

The Bank of England left its key interest rate unchanged at 0.5% at its regular meeting Thursday, even though the United Kingdom has fallen into a new recession.

On Wednesday, the European Central Bank also left its interest rate at 1%. President Mario Draghi said a few members of the bank's rate-setting committee would have preferred an immediate rate cut, and that the ECB is prepared to act if necessary.

Jay Bryson, international economist with Wells Fargo Securities, said Chinese leaders can tell bankers to what industries they want lending increased, far more directly than in Western economies. So the rate cut itself is somewhat less important in China than it is for other central banks' monetary policy.

"The important thing here is they're explicitly signaling they're easing," said Bryson. "It's a green light (that) probably means there will be more easing steps coming."

Bryson said that while 8% growth, or even the 7.5% growth target recently set by the Chinese goverment, would be considered fantastic in the West, the Chinese have to be concerned about unrest if their economy slows too much.

"Back in 2009, the growth rate got down to 6%, and you had factory closings and people losing jobs," he said. "They don't want that to happen."

While investors had been hoping for some kind of action by the Chinese government to stimulate the economy, the timing of the rate cut announcement came as a surprise. Unlike the central banks in the United States and Europe, the People's Bank of China does not have scheduled rate announcements.

So the rate cut announcement at 7 a.m. ET Thursday resulted in a sharp move higher for U.S. stocks in morning trading, as well as European stock markets. Asian markets had already closed for the day by the time the cut was announced. To top of page

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