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This China indicator could derail stimulus hopes

Calls for more monetary stimulus to shore up the world's second largest economy are getting louder amid fresh signs of a prolonged slowdown, but there's at least one reason why Beijing may hold off on easing.

China's broad money supply (M2) in August increased 13.3 percent on-year, according to data released on Friday. This was unchanged from July and a tad higher than Reuters estimates for 13.2 percent, and also maintained the fastest pace of growth since July 2014.

M2 data refers to the entire stock of liquid assets in an economy, such as cash and current account deposits, as well as 'near money' indicators that are less liquid, such as savings deposits and money market mutual funds.

"We have to watch this indicator because if it does continue to expand at this accelerated rate, it could decrease the opportunity for another reserve requirement ratio (RRR) cut," Gavin Parry, managing director of Parry International Trading, told CNBC on Monday.

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If money supply in the economy is increasing, it signifies a higher availability of loans for businesses and individuals that in turn will likely boost overall spending and consumption—crucial to Beijing's transformation towards a more consumer-driven economy.

Meanwhile, M1 money supply—a measurement of the most liquid assets that excludes the 'near money' items contained in M2—accelerated to 9.3 percent on year, much faster than expectations and marking a near two-year high, according to Citi.

"The rising M1/M2 ratio if sustainable implies economic activities were improving," Minggao Shen, Citi economist, said in a Monday note, suggesting Beijing may not further stimulate the economy.

Such views are in stark contrast to the majority of analysts, who expect the People's Bank of China (PBoC) to further reduce RRR levels and interest rates in response to weak data released at the weekend. August industrial production and investment growth weakened further, adding to disappointing trade and inflation reports released earlier last week.

"China data last week and on Sunday scream out for decisive monetary easing," Hong Kong-based Reorient Research wrote in a note over the weekend, reflecting what has now become the consensus view.

The PBoC has already lowered interest rate five times since November and repeatedly relaxed reserve requirements for banks.

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

But not everyone is buying into the 'more-stimulus-is-coming' theory.

"Lending to the real economy is now at its highest since the middle of last year, so actually a lot of the leading indicators are pointing to a rebound for the remainder of this year," Julian Evans-Pritchard, China economist at Capital Economics, told CNBC, referring to the money supply data.

Overall lending growth did fall last month, with Chinese banks recording a smaller-than-expected $12 billion in new loans. But Evans-Pritchard attributed that to the diminishing effects of the government's stock market rescue package that boosted lending to financial institutions.

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He pointed to other upbeat indicators such as credit growth that suggest China's economic situation isn't as bad as broadly thought. Total social financing (TSF), a broad measure of new credit that includes shadow banking loans, rose to $169 billion in August, significantly higher than $112 billion in July.

"It's a good sign that will ease short-term growth concerns...We don't buy into the doom and gloom story in China."

Parry, of Parry International Trading, identified another positive statistic that could further quash hopes for more stimulus.

New consumer mortgage loans increased 51 percent [last month] so we are seeing more activity back into the property side of things, he explained.

"The third consecutive month of 50 percent-ish growth [in mortgage loans] is a hopeful sign for an eventual turnaround in housing starts," agreed Tim Condon, head of research at ING.