PBOC keeps monetary conditions on even keel

The interest rate spread between China and US benchmark debt expanded to the widest level in two years on Thursday, as the Chinese monetary authority decided not to ease monetary conditions after the US central bank lowered interest rates for the third time this year.

Analysts said the wider spread will make yuan-denominated financial assets more attractive for international investors, however, to some extent, it may also indicate liquidity tightening in the market.

The Federal Reserve voted on Wednesday to cut interest rates for the third time this year but downplayed expectations of additional cuts amid a worldwide economic slowdown and fallout from the continuing US-China trade dispute.

The US Federal Open Market Committee (FOMC) cut interest rates a quarter-point to 1.50 from 1.75 percent after reducing rates by a quarter-point each in July and September. Eight of 10 FOMC board members voted to cut rates while two voted to hold rates steady. The action followed nine rate increases since December 2015, including four increases last year.

On Thursday morning, the People's Bank of China, the central bank, decided not to conduct reverse repo operations－a type of open market operation to inject capital into the interbank system, because of the reasonably adequate liquidity, according to a statement on the PBOC website.

The yield on 10-year Chinese government bonds reached 3.3 percent on the same day. Benchmark 10-year US Treasury yields dropped nearly 7 basis points on Wednesday, and gained 1 basis point to 1.78 percent in Asia on Thursday. The interest rate spread between the 10-year Chinese and US government debt is approaching its widest in almost two years.

Following the US Fed's announcement, the Shanghai Composite Index fell 0.4 percent, and the offshore yuan traded up 0.2 percent to 7.0324 per dollar after climbing 0.3 percent on Wednesday.

The central bank again disappointed the market, as no signal of monetary easing has been released.

The rise in consumer price inflation has not presented a major barrier for the PBOC's monetary and credit policy easing, as it was purely driven by surging pork prices, non-food consumer price inflation had already been moderating and product price inflation could fall further into negative territory, said Lu Ting, chief economist in China with Japanese brokerage Nomura Securities.

The central bank could potentially become more reluctant to deliver high-profile policy easing in coming quarters, he said.

Lu's research group forecast that the next cut to the medium-term lending facility (MLF) rate would come in the first half in 2020, when China's CPI inflation likely passes the peak. And the cut to the MLF rate would be helpful in stabilizing market sentiment and bolstering growth.

Han Tan, market analyst at FXTM, a foreign exchange platform, said the US Fed deems the US economy as having sufficient "insurance" after this month's 25-basis point adjustment, that could propel the dollar index back above the psychological level of 98.

"However, if the door is left wide open for more US rate cuts going into next year, that would disappoint investors who are currently betting that the Fed will leave its policy settings unchanged for the December FOMC meeting," said Han.

The Federal Reserve seeks to promote employment, stable prices and moderate long-term interest rates. It is an independent agency and isn't bound by the wishes of the president or Congress. Speaking to reporters at a news conference after the cut was announced, Federal Reserve Chairman Jerome Powell said the "mid-cycle" adjustment he'd discussed for the last five months was probably at an end.

Scott Reeves in New York contributed to this story.