Asia Economy

China rate cut: How bad are things getting?

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

China's third interest rate cut in six months has spurred concerns the mainland's economic slowdown is hitting where it hurts: the labor market.

"The PBOC move validates investors' assumption that sub-par economic performance will be tolerated by the government only up to a point where it does not pose a serious threat to employment," Uwe Parpart, head of research and chief strategist at Reorient Group, wrote in a note on Sunday. "That point may well have been reached."

The People's Bank of China (PBOC) reduced both the benchmark lending and deposit rate by 25 basis points to 5.1 percent and 2.25 percent, respectively, in response to weaker-than-expected economic activity data, which has raised concerns that the government's annual gross domestic growth (GDP) target of "around 7 percent" could be at risk.

Maintaining stable employment has been a top priority for the Chinese government as it steers the world's second largest economy away from an export-driven model to one based on consumption.

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While the labor market has held up in spite of lower growth, initial signs of strain have emerged.

Last month, the Liaoning province government said it slashed its annual job creation target to 400,000 from 700,000, to reflect a "severe" employment trend, according to Reuters. Separately, the labor ministry also warned that authorities should not be "blindly optimistic" as the pace of job creation is slowing.

So, will the rate cut make a difference?

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According to economists, the move should help lower funding costs for the real economy and support economic activity.

"We think this interest rate cut will reduce the financial burden of existing borrowers as most lending contracts use the benchmark rates as a reference, though the reduction will not immediately happen for all borrowers since the period of adjustment is subject to the terms in the specific contracts," Yu Song, economist at Goldman Sachs wrote in a note on Monday.

"The adjustment period is typically monthly, quarterly or annually, with the tendency to shorten in the recent years," Song said

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The average nominal borrowing cost stood at 6.8 percent in the January-March period, according to the PBOC's first quarter monetary policy report, a factor that has hampered activity in capital-intensive industrial and manufacturing sectors.

However, the rate cut is unlikely to mark the end of policy support, say economists.

"Economic momentum is weaker than most had anticipated,"Mark Williams, chief Asia economist at Capital Economics, who expects a further 150 basis point reduction in banks' reserve requirement ratio (RRR) before year-end, wrote in a note on Sunday.

"Of course, this will only help the economy if demand is there. The likely reduction in real interest rates in the months ahead should help, but the government will play a part too by speeding up spending on infrastructure and other government-led investment," he said.