China should guide rates lower to support growth, former central bank official says

© Reuters. FILE PHOTO: People wearing face masks walk at a main shopping area, following the coronavirus disease (COVID-19) outbreak in Shanghai, China January 27, 2021. REUTERS/Aly Song

BEIJING (Reuters) - China should guide market interest rates lower to support economic growth and ease funding pressure on local governments, a former central bank official said, adding to the debate over whether Chinese and U.S. monetary policy will diverge further.

Reasonable rate cuts also would help create space for the People's Bank of China (PBOC) to tighten policy if needed in the future, in order to cope with an expected weakening in the yuan, Sheng Songcheng, former head of statistics at the PBOC, said in a column published late on Tuesday on Sina (NASDAQ:SINA) Finance, a financial news outlet.

"It's necessary to keep liquidity reasonable and sufficient, and guide the rational and moderate decrease of market interest rates," Sheng said, adding that economic growth is likely to slow to 5-6% in the second half of the year, from an expected pace of around 8% in April-June.

Chinese treasury futures rose sharply on Wednesday afternoon on Sheng's comments.

Policy tightening in the future will help ease depreciation pressure on the yuan caused by rising capital outflows from China once the U.S. Federal Reserve starts to tighten policy from emergency pandemic levels, Sheng said.

The Fed surprised investors last month by signalling it could start raising interest rates in 2023 or even next year, earlier than expected, as the U.S. economy recovers. Some other global central banks have already started normalising policy.

Chinese officials, however, have pledged to make no sharp policy u-turns and markets expect key rates will be kept unchanged through at least this year.

In June, the PBOC left its benchmark lending rate for corporate and household loans unchanged for the 14th straight month. It did not cut its key rates as sharply as many other central banks in the initial stages of the COVID-19 pandemic, as the government was quicker to roll out fiscal stimulus measures and aid to struggling companies.

Policy changes by the Fed will have a limited impact on China's financial markets, a Chinese central bank official said in April.

China's economy expanded at a record rate of 18.3% in the first quarter, but the reading was highly skewed by comparisons with early 2020 when activity was paralyzed by the COVID-19 outbreak and sweeping lockdowns to contain it.

However, while much of the economy is clearly back at pre-pandemic growth levels, the recovery has been uneven, with softness in consumption and investment. Many analysts say pent-up COVID demand has peaked and forecast that growth rates are starting to moderate.

Ting Lu, chief China economist at Nomura, told reporters on Wednesday that he expected the central bank to maintain a modest tightening stance, with no rate cuts or rises expected in the second half.

"China's policy response towards the COVID-19 pandemic has been different from the past rounds of easing, and one key factor is the strength in exports so that policymakers did not need to resort to mass stimulus in property and infrastructure sectors," he said.