Beijing dusts off an old lever

While analysts warned China's rate cut could exacerbate its existing imbalances, others argued the gloomy US jobs market could force Ben Bernanke to turn on the stimulus tap sooner than expected.

The global stock market rally started to run out of steam overnight, as investors fretted that global central banks might lack the firepower to counteract the sharp slowdown in the global economy.

Investors were initially cheered by Beijing’s decision to cut interest rates for the first time since December 2008, in order to boost activity in the world’s second-largest economy ahead of the once-in-a-decade leadership transition.

China’s central bank cut its benchmark interest rate for both loans and deposits by 25 basis points. The move, which brings the one-year lending rate to 6.31 per cent, will provide some relief to embattled borrowers, particularly property developers, and exporters.

In addition to the rate cut, the People’s Bank of China announced that banks would be given more leeway in determining rates. From now on, banks will be allowed to pay savers an interest rate that is 10 per cent above the benchmark deposit rate of 3.25 per cent, and to offer borrowers a discount of up to 20 per cent on the benchmark lending rate (currently banks can only offer a 10 per cent discount).

As a result, the banks will be able to charge a maximum deposit rate of 3.58 per cent, and a minimum lending rate of 5.05 per cent.

Beijing policymakers are hoping that this move to increase deposit rates will funnel more money into the pockets of savers, allowing them to increase their spending, as well as discouraging speculation.

At present, Chinese savers, who earn an interest rate on their savings which is below the inflation rate, have a strong incentive to pour their savings into physical assets, such as real estate, in the hope of earning higher returns.

But some analysts warn that cutting interest rates will exacerbate the existing imbalances in the Chinese economy by reinflating the country’s real estate bubble, and encouraging even higher levels of over-investment.

Others claim that the Chinese rate cut will do little to spur activity. They claim that the recent weakness in bank lending is not because interest rates are too high, but because borrowers are reluctant to borrow. Chinese exporters are suffering as Europe – which is China’s largest export market – falls deeper into recession, and the outlook has become so grim that many people are now reluctant to take on new loans to fund further investment.

Meanwhile, investors were discouraged after Ben Bernanke, the boss of the powerful US central bank, appeared to douse hopes of another quick round of monetary stimulus.

Appearing before the joint economic committee of Congress, Bernanke said that he and his colleagues were "still working” on the question of whether to provide more monetary stimulus in order to boost growth. This, he said, would depend on whether they considered the US economy was strong enough to significantly reduce unemployment.

He was also critical of Congress’s failure to come up with a credible medium-term fiscal policy. "Monetary policy is not a panacea, it would be much better to have a broad-based policy effort addressing a whole variety of issues," he said. "I’d be much more comfortable if, in fact, Congress would take some of this burden from us and address those issues.”

According to Bernanke, the US economy looks set to keep growing at a "moderate” pace, although he noted that there were risks from Europe’s spreading financial turmoil, which was harming US exports, denting business and consumer confidence, and creating strains in US financial markets. The US central bank, he said, was "prepared to take action” if these stresses increased.

Investors had been hoping that the US central bank would agree on a fresh round of asset purchases – dubbed QE3 – at its next meeting later, and some were disappointed that Bernanke seemed to suggest that the US central bank would only act if the situation deteriorated further.

But others argued that the gloomy US jobs market means that Bernanke will be forced to provide fresh stimulus.

Because the US economic recovery has been so anemic, around one in seven Americans are currently either unemployed or underemployed. And the number of people who have been out of work for long periods of time is growing, with the long-term unemployed now making up 42 per cent of the total – the highest level since the Great Depression.

At present, some 45 million Americans – or one in seven residents, are now on food stamps, while a staggering 47 per cent of Americans receive some form of government assistance.

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