China ‘ahead of US’ in monetary policy adjustments, as US Fed revamps interest rate predictions

Lujiazui Forum, financial de-risking campaign, 9 trillion yuan, keeping a close eye on, dynamically optimising

Economists say China is better positioned than it was in the past to handle “external challenges”, after the US Federal Reserve overhauled its economic and monetary policy predictions in its just-concluded policy meeting.

The Fed’s so-called dot plot – a chart showing when each member of the Federal Reserve’s policymaking panel expects the central bank to change interest rates – implies that hawkishness is on the horizon, with two projected interest rate hikes by the end of 2023, according to a statement released by the policymaking Federal Open Market Committee on Wednesday in Washington.

While keeping its benchmark rate and its US$120 billion-per-month quantitative easing asset-purchasing programme unchanged for now, the Fed said it would be prepared to adjust its monetary policy as it balances various risks in the coming months, particularly with inflation rising in the United States faster than expected.

“It has formed a consensus on tightening. The only difference is the timing, not the direction,” said Cheng Shi, chief economist at ICBC International. “The more-hawkish-than-expected adjustments raise the curtain for de facto monetary policy normalisation in the US, or even the whole world.”

Chinese financial officials have long expressed concern about spillover effects from expansionary US monetary and fiscal policy – such as the pressure it puts on the yuan exchange rate, capital flows and cross-market contagion risks – and the painful reactions in some emerging markets, such as unexpectedly large interest rate hikes in Russia, Brazil and Turkey.

“The US Fed policy adjustment will impact the global foreign exchange market and cross-border capital flows,” Pan Gongsheng, deputy central bank governor, said at the Lujiazui Forum in Shanghai last week.

“It may also drive up risk-off sentiment,” he added, referring to when traders and investors reduce exposure to market risks in an effort to protect their capital.

The People’s Bank of China, which says it has implemented a “normal” monetary policy, was silent on Thursday over the move across the Pacific.

It sold 10 billion yuan (US$1.56 billion) worth of seven-day reverse repurchase agreements to the interbank market on Thursday to maintain reasonably ample liquidity in the banking system, and their 2.2 per cent one-year bench interest rate has remained unchanged since April 2020.

China has taken the initiative in monetary adjustments and now actually walks ahead of the US [Fed]

Zhou Xuezhi, Institute of World Economics and Politics

These so-called reverse repos are short-term agreements in which the central bank buys securities from commercial banks while agreeing to sell them back later.

Beijing paid a hefty price in the previous cycle of rising US interest rates. After the US Fed, then chaired by Janet Yellen, who is now US Treasury secretary, ended its previous programme of quantitative easing in 2014, the world’s second-largest economy experienced a stock market crash and massive capital flight. This forced China to burn through nearly a quarter of its forex reserves to support the yuan’s exchange rate.

Zhou Xuezhi, a researcher with the Institute of World Economics and Politics under the Chinese Academy of Social Sciences, said he believed that Beijing was much better positioned to handle external challenges this time around.

“China has taken the initiative in monetary adjustments and now actually walks ahead of the US [Fed],” Zhou said.

China’s policy approach began to diverge from that of the US in 2018, when Beijing started a three-year financial de-risking campaign. And last year, China’s 9 trillion yuan (US$1.4 trillion) stimulus was much smaller than that seen in the United States and some other Western countries, and it started reducing fiscal and monetary stimulus when the pandemic was brought under control domestically in the second half of 2020.

Zhou said the US tapering could affect some capital inflows, which Beijing is now keeping a close eye on, but it would help regulators manage the yuan’s exchange rate.

“The yuan’s rise may come to an end for the time being,” he said.

Chinese financial authorities have adopted measures in recent weeks to fight one-way bets on the yuan’s appreciation, including raising the reserve requirement for banks’ foreign exchange deposits and “dynamically optimising” its foreign exchange reserves strategy.

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