Why China’s interest rate cut may be bad news for the world economy, by Larry Elliott

From Larry Elliott at the guardian.com:

The People’s Bank of China was preparing to spring a surprise while President Xi Jinping was taking a selfie with Manchester City star Sergio Aguero. On Friday, the central bank in the world’s second-biggest economy cut the cost of borrowing for the sixth time in a year.

This move has implications, none of them especially cheery despite the knee-jerk increase in share prices that followed. Those investors who thought the announcement in Beijing was a big buy signal should ask themselves whether this was a sign of strength or a sign of weakness.

It is worth noting that the interest rate move came just days after China released official figures showing that the economy’s annual growth rate had slowed down in the third quarter, but only to a still healthy looking 6.9%. After all the stock market turmoil in August, that was a strong performance and it had the desired effect of reassuring markets that the authorities were in control of the planned rebalancing of the economy towards more modest but better quality growth.

But as all commentators know, China’s official figures are not worth the paper they are written on. The fact that interest rates were cut four days after the latest growth data was released underlines the point. Danny Gabay at Fathom thinks China’s real growth rate is 3%, and the rate cut late on Friday night suggests he is right.

The good news for the PBoC is it has plenty of scope to cut rates further from their current level of 4.35% should the economy not respond to the stimulus provided. Unlike other central banks, it has not already cut the official cost of borrowing to zero (and in some cases below zero). The bad news is that it might need all the leeway it has available. That’s certainly the view of Gerard Lyons, a China expert at Standard Chartered before he became economic adviser to Boris Johnson. Lyons thinks that sooner or later China will join the rest of the central bank pack.

But it is not just in China that things are looking a bit dicey. On the day before the PBoC cut rates, the European Central Bank dropped the broadest of hints that in December it will announce new growth-boosting measures for the eurozone. Mario Draghi, the ECB’s president, has options. He could cut the ECB’s deposit rate, already -0.2%, still further and thus penalise banks that want to park money with the central bank. More likely, though, the ECB will turn to its version of quantitative easing and increase its bond-buying programme from the current €60bn (£43bn) a month.

Japan is also poised to provide more stimulus later this week when official figures are likely to show the economy back in recession. As with the ECB, a central aim of the policy is to secure a competitive advantage by bearing down on the exchange rate. But if the yen and the euro are weakening, something else has to be strengthening, and the upshot will be that the US dollar will rise.

With the US economy showing signs of slowing, the Federal Reserve, America’s central bank, will put on ice any plans to raise interest rates, for fear that this will drive the dollar even higher.

So what’s the problem? China, Japan and the eurozone are all easing policy. The US is going to delay tightening policy. More stimulus equals stronger growth and fends off the threat of deflation. That’s got to be good, hasn’t it?

To continue reading: Why China’s interest rate cut may be bad news

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