China further slashes lending rate by 31bp

But what came as a major surprise was that banks were allowed to set their lending rate as much as 70% lower than the limit.

The People's Bank of China announced that it will cut 1-year deposit rate by 25bp, and cut the 1-year lending rate by 31bp, effective July 6. This follows the 25bp interest rate cut on June 7.

Further interest rate deregulation as also announced with the banks set their lending rate as much as 70% lower than the benchmark rate.

According to Nomura, this was not expected and so a positive surprise to the market.

Here's more from Nomura:

There were high expectations that the bank RRR would be cut, but cutting interest rates instead is a stronger form of monetary policy easing.

The rationale for cutting interest rates instead of RRR could be that the demand for loans remains weak; it could also hint that the slew of data out next week, including Q2 GDP growth could be on the weak side (Consensus is 7.8% y-o-y). It also suggests that CPI inflation (due 9 July) could fall sharply (indeed we expect it to fall from 3.0% y-o-y in May to 2.2% in June).

Cutting the lending rate by more than the deposit rate could further squeeze bank interest rate margins. Allowing banks to set the lending rate at 70% below (previously the limit was 80% below) the benchmark lending rate was a major surprise. This is further interest rate deregulation (last month, the lending rate floor was lowered from 90% to 80%, and the deposit rate ceiling was raised to 10% above the benchmark rate) and a positive sign that, despite the political transition of leadership, Beijing is continuing with much needed financial reforms.

Interest rate deregulation is important to encourage banks to become more commercial in order to properly price risk, and it suggests that capital account liberalization and bond market deepening will continue as all these reforms need to occur in tandem. This strengthens our view that the economy will rebound in H2 to approach 9% y-o-y GDP growth by Q4. We will be reviewing our forecasts to reflect further monetary policy easing (currently we expect one more RRR cut of 50bp in Q3).