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China fires growth salvo, is monetary easing next?

People's Bank of China in Beijing, China
Getty Images
People's Bank of China in Beijing, China

Now that China has announced a mini package of fiscal stimulus measures to bolster flagging growth in the world's second largest economy, there's increasing chatter of more support to come in the form of monetary policy easing.

According to China watchers, the People's Bank of China (PBOC) is likely to follow with cuts to banks' reserve requirement ratio (RRR) in the coming months, with a rate cut possibly on the cards as well.

(Read more: Is China about to launch a new round of stimulus?)

"It seems that the government has come around to the view that the economy needs stimulus. The measures they have announced are small and targeted, and because of that, it can't be the end of it. They have to do more," said Dariusz Kowalczyk, senior economist, Asia ex-Japan at Credit Agricole.

The government late Wednesday unveiled initiatives to support growth including cutting taxes for some small and micro-sized enterprises and measures to stabilize exports and speed up railway investment. Economists expect the policies to reduce downside risks to growth and boost confidence in the government's handling of the economy.

(Read more: China offers further pro-growth policy fine-tuning)

Kowalczyk said he expects the country's central bank to cut the RRR by 50 basis points in the fourth quarter in order to restore liquidity to levels seen before the cash squeeze in mid-June, when a spike in interbank market rates resulted in a crunch for banks.

Zhiwei Zhang, chief China economist at Nomura, also expects the central bank to cut the RRR, forecasting a 50 basis point reduction in both the third and fourth quarter, in order to offset the negative impact of capital outflows on domestic liquidity conditions.

China experienced strong capital outflows in June, reflected in the foreign exchange purchases by financial institutions, which fell by 41 billion yuan ($6.6 billion) to 27.39 trillion yuan last month, according to central bank data.

(Read more: What if China lands hard? SocGen outlines the scenario)

Interbank lending rates, in fact, have been creeping up in the recent days, with the one-month Shanghai Interbank Offered Rate (SHIBOR) rising above 5 percent for the first time since July 4 on Thursday, according to IG Markets, raising some concern over near term liquidity conditions.

Li-Gang Liu, chief economist of Greater China at ANZ, believes the central bank may go as far as cutting rates sometime this quarter.

"The very sluggish economy and rising unemployment rate will force them to cut rates. With the credit squeeze, China's money market rates already went up. Therefore, a rate cut is already long overdue," Liu said.

(Read more: Beijing loosens grip on rates—will it matter?)

China's labor market ministry on Thursday said the country's faces big pressure on employment as it moves to solve structural problems that have led to overcapacity in some industries, Reuters reported.

"The PBoC's policy stance is inconsistent to the macroeconomic conditions," Liu added.

—By CNBC's Ansuya Harjani; Follow her on Twitter: @Ansuya_H

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