By Winni Zhou and Kevin Yao
SHANGHAI/BEIJING (Reuters) - China lowered its new lending reference rate slightly on Tuesday, as expected, as the country's central bank kicked off new interest rate reforms designed to lower corporate borrowing costs.
But the tiny reduction in the revamped Loan Prime Rate (LPR), which is calculated from price contributions from selected banks, reflects lenders' reluctance to reduce loan rates. That has fuelled expectation Beijing will need to take more steps to guide borrowing costs lower in a struggling economy.
The modest reduction in the lending rate comes after the People's Bank of China (PBOC) on Saturday designated the LPR the new lending benchmark for new bank loans to households and businesses, replacing the central bank's existing benchmark one-year lending rate.
The new one-year LPR was set at 4.25% on Tuesday, down 6 basis points from 4.31% previously. It was 10 basis points lower than the PBOC's existing benchmark one-year lending rate.
"While this should nudge banks to reduce lending rates slightly, the impact on economic activity will be marginal," Capital Economics Senior China Economist Julian Evans-Pritchard said in a note. "A decline of only a few basis points is small."
He also said the PBOC would need to take other steps, including cuts to medium-term liquidity rates, if it wants to continue reducing the LPR to lower funding costs for banks.
The new five-year LPR rate was set at 4.85%, according to the PBOC's national interbank funding centre, which was below the five-year benchmark lending rate of 4.90%.
MARKET GUIDANCE
Under the reforms, the LPR will broadly track changes in the PBOC's medium-term lending facility (MLF) rates, making banks' lending rates more market-based. MLF rates are generally seen as the rates banks pay for their funding and are determined through the central bank's open market operations bidding process.
Analysts say the reforms are an official attempt to lower financing costs in the world's second largest economy, which has faced continued pressure from weakening demand at home and an extended trade war with the United States. The new mechanism would force banks to price their loans closer to market rates, a move which could hurt lenders' profit margins.
Despite economic growth nearing 30-year lows, analysts say the PBOC has been reluctant to cut interest rates system-wide due to fears of a further surge in debt and possible property bubbles. It last cut the one-year lending rate in 2015. Indeed, existing loans including mortgages are still exempt from the new benchmark scheme.
"To all intents and purposes it is a 'stealth' easing policy," brokerage Jefferies wrote in a note.
Some market participants expect the central bank will cut the interest rate on one-year MLF, which could essentially bring the LPR down further.
A batch of one-year MLF loans worth 149 billion yuan (17.38 billion pounds) is set to mature on Monday. If these loans are rolled over, the PBOC could adjust their rates lower.
Wen Bin, chief economist at Minsheng Bank in Beijing, expected reductions in MLF rates to come next month. He said that if the U.S. Federal Reserve cuts interest rates on Sept. 18, the PBOC is likely to lower the MLF rate by 15-20 bps, which would in turn push LPR rates lower.
"The first rate came in higher than expected," Li Wei, China economist at Standard Chartered (LON:STAN) Bank, said, expecting LPRs to trend lower in coming months.
The LPR, originally introduced by the PBOC in October 2013, is an interest rate that commercial banks charge their best clients and was intended to better reflect market demand for funds than the benchmark the PBOC sets.
