China May Start Easing Monetary Policy, BNP Says

China’s policy makers may start easing monetary policy in the coming months as bond yields signal that the economy is heading for a “hard landing,” BNP Paribas said.

The curve tracking the difference between the yields on 2-and 5-year bonds has “collapsed” in the past 10 days and an inversion may signal a recession in China, BNP strategists Clive McDonnell and Ryan Tsai said in a report today. That outcome would be “unthinkable” for China, they said.

“While the yield curve is telling us that the economy is heading for a hard landing, we believe there is no appetite among policy makers for such an outcome,” the strategists wrote.

China has ordered lenders to set aside more deposits as reserves three times this year, while implementing curbs on property speculation ranging from a ban on loans for third-home purchases to higher down-payment requirements for second homes.

Even amid the tightening, the People’s Bank of China has yet to raise interest rates from crisis levels and officials haven’t abandoned the yuan’s peg to the dollar, adopted in July 2008. The benchmark one-year lending rate will be raised by Sept. 30, according to 19 of 20 economists surveyed by Bloomberg News this week, with 10 predicting an increase as early as this quarter. Twelve out of 18 expect the yuan to rise by June 30, the survey showed.

“Given the multiple levers that Chinese policy makers use to influence monetary policy, it is possible that interest rates could rise at the same time policy is being eased,” the BNP strategists said.

Outlook for Growth

China’s gross domestic product increased 11.9 percent in the first quarter, the fastest pace in almost three years. Growth will only start to slow in the second quarter, according to BNP.

As growth slows, the yield curve may start to steepen, indicating investor expectations of easing monetary policy, according to the report. That may signal that Chinese stocks, among the world’s worst performers this year, are poised to “re-rate,” the strategists said.

The Shanghai Composite Index entered its second bear market in nine months this week and has dropped 19 percent this year, the third-worst performer among 93 measures tracked by Bloomberg globally. The Hang Seng China Enterprises Index of Hong Kong- traded Chinese shares has lost 8.8 percent in 2010.

“The time to move back into China equities is approaching,” the strategists wrote. “We are not there today.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE