Last night, the 7-day reverse repo rate, the main rate of the People’s Bank of China, unexpectedly dropped by 10 basis points to 1.7%. According to Commerzbank’s currency strategist, Folkmar Baur, this is the first rate cut since August last year.

Anticipated positive market response

Due to China’s capital controls and unique economic characteristics, the impact of credit and monetary policy on the currency is less significant compared to other currencies. However, the reduction in the benchmark rate has a particular signaling effect.

Expectations for short-term impulses from the recently held Third Plenum were low. This meeting mainly focused on long-term events and reforms. While the initial communique was somewhat underwhelming, the more detailed documents released over the weekend present a more optimistic outlook for constructive reforms, particularly in fiscal policy.

The signal of support from the People’s Bank of China holds great importance in the near future, given the weak growth indicators in the second quarter. The upcoming official meeting of the Politburo further raises expectations for additional support measures. It is anticipated that the market will consider more negative scenarios of a significant growth slowdown, ultimately lending support to the yuan.