The 1Y LPR was kept unchanged at 3.35% yesterday, suggesting that banks and authorities are awaiting the effects of recent stimulus measures following last month’s unscheduled 20 bps cut. Coupled with the unchanged 7D repo rate, we expect the PBOC to keep the 1Y MLF rate unchanged next week.
That said, the weakening growth momentum suggests another round of rate cuts in Q4. Credit demand remains weak, with new yuan loans registering the first contraction on record. Real funding costs have stayed elevated amid modest consumer inflation and contracting producer inflation. Reportedly, local governments will be allowed to direct funding raised from special bonds to buy unsold properties. However, the effectiveness of this initiative could be limited without further rate cuts. Notably, the outstanding local government special bond yield remained elevated at 3.20% as of June. On the external front, the window for a benchmark rate cut has emerged as major central banks begin their rate cut cycles. Depreciation pressure on the CNY from further PBOC cuts would be manageable.
All told, CGB yields are likely to fall further due to rate cuts. Short-end rates will likely have more room for retreat after the recent rebound. Meanwhile, the downward pressure on long-end rates will be partly offset by increased issuance to support growth. The PBOC's primary market bond borrowing, and subsequent sales will also help keep long-end yields steady and maintain an upward-sloping CGB curve.
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