China sets new lending reference rate slightly lower on first day

CHINA - SHANGHAI. China's new lending reference rate was set slightly lower on Tuesday in the first publication of the benchmark since the central bank announced interest rate reforms designed to lower corporate borrowing costs.

The People's Bank of China (PBOC) on Saturday said the Loan Prime Rate (LPR) would become the lending benchmark for banks when setting rates for new loans to households and businesses, instead of the central bank's existing benchmark one-year lending rate.

The new one-year Loan Prime Rate 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.

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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.

The new five-year LPR rate was set at 4.85%, according to the national interbank funding centre. That's below the five-year benchmark lending rate of 4.90%.

Analysts and investors 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.

As the new LPR will be linked to rates set during open market operations, namely the PBOC's medium-term lending facility (MLF), investors will closely watch any changes in the borrowing costs that the central bank charges its liquidity tool.

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Some market participants expect the central bank to cut the interest rate on one-year MLF, as that could essentially bring the LPR down further.

"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 and, unlike a benchmark lending rate cut, it will only feed through to borrowing costs on new loans, not outstanding ones."

A batch of one-year MLFs with a value of 149 billion yuan is set to expire on Monday, which could see the rates on that facility adjusted.

"If the PBOC wants to continue to push down LPR it will need to take other steps, including cuts to MLF rates, to lower funding costs for banks," Evans-Pritchard said.