World stock markets soared on Friday as China’s central bank moved to head off a sharp slowdown in growth with its first cut in interest rates for two years.
The People’s Bank of China said it would lower its one-year benchmark lending rate at the weekend by almost half a percentage point to 5.6% and cut its one-year deposit rate amid concerns that the world’s second largest economy is weakening. The FTSE 100 closed 1% higher at 6750.76 on Friday, while the Dow Jones was also higher in early trading.
Analysts said one of the main effects of the interest rate cut would be to force down the yuan against the yen and the dollar, helping China to export its way out of trouble. The yuan has already fallen 10% against the dollar since the summer from a level that was widely regarded as overvalued and may have further to go in the coming months as the economy struggles and the US recovery gathers pace.
The interest rate cut will be welcomed by the millions of Chinese homeowners who pay a large proportion of their salary each month on mortgage payments. Rocketing mortgage debt has become a huge problem in China alongside the massive debts racked up by state enterprises and local authorities.
Officials at the central bank, aware that many homeowners have reduced spending on other items, will hope lower borrowing costs and the cut in deposit rates will encourage them to boost expenditure in other areas of the economy.
China’s slowdown was highlighted by David Cameron as one of his red warning lights signalling the danger of a second financial crash. He said faltering growth in emerging markets was a cause for concern alongside the escalating dispute in Ukraine and the Ebola crisis.
Beijing has maintained that GDP growth continues to stay above 7%. Government figures for the third quarter this year estimated growth at 7.3%.
However, this was the slowest pace for more than five years and unofficial estimates have put growth at no higher than 5%. While even this rate of expansion is still almost double the UK’s rise in GDP this year, many economists believe China needs to grow by at least 6% a year just to keep pace with population growth.
Beijing has already seen its manufacturing output come perilously close to contraction after hitting its lowest level for six months in October. The HSBC flash PMI reading dropped to 50.0, down from the previous month’s 50.4, with a reading above 50 indicating expansion in the sector.
The manufacturing data is the latest in a steady stream of weaker-than-expected indicators in recent weeks as trading conditions remain difficult. Credit and investment growth have also slowed.
Marc Ostwald, a strategist at broker ADM ISI, warned China’s rate cut could spark a currency war among other emerging nations in the region.
“One can certainly also expect a response from South Korea and others in south-east Asia and a rate cut from India’s central bank also seems likely.”
European Central Bank (ECB) boss Mario Draghi also strongly hinted that he plans to drive the euro lower to help eurozone economies become more competitive.
Draghi said that if current measures were not enough to spur growth and prevent inflation from settling at uncomfortably low levels, the ECB’s governing council would “broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our purchases”.
Nick Kounis, head of financial markets research at ABN Amro, said: “Draghi all but announced that the central bank will step up monetary easing soon. Mr Maybe has become Mr Definitely – striking an even more dovish tone than at the press conference earlier in the month.”
The ECB has already set out proposals to increase its funding to the financial markets to €2tn and this plan could entail joining the quantitative easing programme adopted by the Bank of England and US and Japanese central banks.
