Central Banks

After rate cut, what's next from PBOC?

The People's Bank of China in Beijing's financial district.
Tomohiro Ohsumi | Bloomberg | Getty Images

The Chinese central bank's second rate cut in three months will not be enough to halt a downturn in the world's second largest economy, with more easing steps needed, say economists.

The People's Bank of China (PBOC) cut benchmark interest rates by 25 basis points to 5.35 percent on February 28 as deteriorating economic conditions forced the central bank to shorten the time gap between policy moves. It had already delivered a lending rate cut on November 21 and a reserve requirement ratio cut (RRR) on February 5.

The rate cut, which came sooner than some analysts had expected, was announced hours before the release of the official purchasing managers index (PMI) for February, which showed the country's manufacturing activity contracted for a second straight month.

More steps needed

"Against this backdrop, we think more easing steps will follow," said Louis Kuijs, chief China economist at the Royal Bank of Scotland. "This is needed to ensure that GDP (gross domestic product) growth will not fall too much below 7 percent in 2015 – what we expect will be announced as this year's target during the NPC (National People's Congress) meeting that starts March 5. "

A further reduction in the benchmark lending rate and RRR are in the pipeline, say economists.

What spurred China's interest rate cut?
What spurred China's interest rate cut?

"The next move is likely to be a RRR cut, likely in 2Q, but a cut towards the end of 1Q cannot be ruled out (RRR cut is also a tool of liquidity management)," said Yu Song, economist at Goldman Sachs.

"Further benchmark interest rate cuts are also possible. The government is also loosening other policies such as allowing the exchange rate to depreciate modestly against the [U.S. dollar] and stepping up infrastructure investments," he said.

China's yuan fell to its weakest level against the U.S. dollar since October 2012 early Monday.

HSBC expects one more lending rate cut and RRR reduction in the second quarter.

Read MoreChina cuts benchmark interest rates by 25 basispoints

"More easing, beyond the latest lending rate cut, has to be carried out to bring about a material fall in cost of financing within the system," said André de Silva, Head of Asia-Pacific Rates Research at HSBC.

"Recent money market conditions still paint a tough financing picture. The 7-day interbank repo rate reached 4.99 percent as of 28 February, way above the past year average of 3.60 percent. The money market is the basic building block of financing and with such high levels, it is extremely difficult to expect companies' cost of funding to fall," he said.

Just the beginning

With China's growth under continued pressure, monetary easing is poised to become a dominant theme in the mainland – a clear policy divergence from the U.S., where the Federal Reserve is gearing up to tighten the monetary screws.

Steve Wang, chief China economist at Reorient Financial Markets says of all the major economies, China has the most room for monetary ease.

Inflation in the mainland has fallen from 2.5 percent in January 2014 to just 0.8 percent in January 2015 and the slowdown in domestic demand means there's scope for inflation to ease further, say economists.

"We believe that additional monetary stimulus will be positive for Chinese equities," he added.

The benchmark was flat early Monday as investors digested the weekend's rate cut.