China cuts rates via a new tool - ING

Iris Pang, the economist for Greater China at ING, notes the People's Bank of China (PBoC) cut the one-year loan prime rate (LPR) by five basis points to 4.2% while keeping the five-year LPR rate unchanged at 4.85%.

• "We believe that the decision to cut the rate came from very weak August data released a few days ago. Industrial production grew just 4.4% year-on-year, the lowest level since February 2002, while fixed asset investments grew 5.5%, down from 5.7% previously, even with support from infrastructure stimulus.
• A 5 bps cut in the one-year LPR will guide interest rates lower in bank loans and other financial assets, including local government special bonds which are used to fund infrastructure projects. This means that production costs and investment costs will be lowered slightly. 
• As the trade war is expected to continue for some time, this rate cut is clearly necessary.
• A rate cut doesn't necessarily mean a weaker yuan. There is very little arbitrage opportunity given that China's capital account is not fully open. Put simply, the theory that lower interest rates weaken the currency doesn't apply in China.
• USD/CNY peaked at 7.1054 on Thursday then closed at 7.0965. After the rate cut today, the USD/CNY moved to 7.0903. That is, the yuan actually strengthened rather than weakened. 
• We expect a weaker yuan if the trade talks go poorly. Our USD/CNY forecast is 7.20 by the end of 2019. "