Jun. 8 – To the surprise of many, the People’s Bank China (PBC) lowered its interest rate yesterday for the first time in years. The 25 basis points cut takes the one-year lending rate to 6.31 percent and the one-year deposit rate to 3.25 percent.

With the rate cut, the PBC aims to boost the investment and growth by reducing the cost of borrowing. However, the cut surprised many experienced economists and policy makers who believed the PBC would refrain from cutting policy rates.

Also, extra freedom will be given to banks to set their own lending and depositing rates from June 8. The deposit rates could be set as high as 110 percent of the standard rate and offer rates on new loans as little as 80 percent of official policy rates, an additional 10 percentage points below the current 90 percent limit.

“It’s obviously a very strong signal that the government wants to boost the economy, given the current weakness, especially in demand,” Qinwei Wang, economist at Capital Economics in London, told Reuters.

“It’s a significant move,” Wang added. “It’s a first step in rate liberalization and it increases the returns for households. The lower floor for lending rates creates more competition between banks. So banks cannot guarantee their profits as before.”

Moreover, the cut is a building foundation for China’s interest rate liberalization, which has been anticipated by many experts and economists for years.

“It’s clear that policy makers have their finger on the trigger,” comments Francis Yared, a bond strategist at Deutsche Bank, according to the Financial Times.

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