With China's November factory activity sinking to a 32-month low, analysts say China's central bank will almost certainly ease monetary policy in the coming months. That in turn, could boost the country's languishing stock market, which is down 14 percent so far this year.
However, with the economy still growing at 9 percent, none of the analysts expect the People's Bank of China to cut interest rates, which are currently at 6.56 percent on one-year loans. They believe the cut will come in the reserve requirement ratio (RRR), which at 21 percent for the largest lenders, is among the highest in the world.
"A lot of small to medium sized companies are starting to find themselves in financial trouble," Alvin Chong, Head of Research at Sun Hung Kai Financial, told CNBC on Wednesday. "So in order to lubricate their businesses it would make sense for China to gradually lower the RRR to free up capital."
According to Reuters, reserve ratios for five rural credit cooperatives in Zhejiang have already been cut by 50 basis points. John Tang, China Strategist at UBS, believes the central bank is using the Zhejiang cuts to test the market’s reaction.
"I think they want to release this information to see how the market's going to react," he said on Wednesday. "If the market reacts healthily on that, we may see more on the reserve requirement."
Tang has already upgraded a number of cyclical sectors such as real estate, believing the monetary easing will support stocks. "Now's not the time to remain super-defensive," he said.
The decline in consumer prices has given the central bank, much more room to act, according to Shane Oliver, Head of Investment Strategy and Chief Economist at AMP Capital.
"The inflation story is now a non-event, it's going out of the door quickly," he said. "The November inflation figures, when they're released in a couple of weeks, are probably going to show inflation somewhere around 4.5 to 5 percent, i.e. well below the July peak of 6.5 percent."
John Tang believes that an easing in the reserve ratios could lead to a rebound in the purchasing manager's index over the next 2 months.