In June, the MLF "modest volume reduction and flat pricing" was continued without a rate cut. On June 17th, to maintain a reasonable abundance of liquidity in the banking system, the central bank carried out 4 billion yuan in open market reverse repo operations with a winning bid interest rate of 1.80%; at the same time, it conducted 182 billion yuan in Medium-term Lending Facility (MLF) operations with a winning bid interest rate of 2.50%, which was consistent with the previous rate. There was a maturity of 237 billion yuan in one-year MLF for the month, resulting in a net withdrawal of 55 billion yuan, making the June MLF a "reduced volume and flat pricing" continuation.

In fact, under the "dual constraints" of internal and external factors, the market had anticipated that the MLF rate would remain unchanged in June. On June 14th, a person close to the regulatory authority told the reporter that the current policy interest rates in our country are relatively low, and the support of monetary policy for the real economy is solid. In the future, counter-cyclical adjustments will continue to be made in conjunction with changes in the situation. Objectively speaking, further rate cuts face "dual constraints" from both internal and external factors.

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This is because, internally, stabilizing interest rate spreads and preventing risks are still influencing factors; externally, the renminbi exchange rate is also an important consideration.

From a comprehensive market analysis, against the backdrop of the stable MLF operation rate in June, it is highly probable that the June LPR (Loan Prime Rate) will remain "unchanged." Subsequently, in order to reduce financing costs and maintain the stability of banks' net interest margins, there is still some room for LPR reduction, and the timing of reserve requirement ratio cuts and interest rate cuts has been postponed, but there is still room for implementation.

The urgency to lower policy interest rates is not high.

Recently, the pace of bank credit has slowed down, and the liquidity in the banking system is relatively abundant, with commercial banks having a low demand for MLF operations.

The June MLF maturity amount is 237 billion yuan, continuing to be at a low scale; the operation scale for the month is 182 billion yuan, which means a reduced scale of 55 billion yuan for the month. Recently, the MLF injection volume has been low, generally in a state of reduced volume or equal volume continuation, affected by weak credit demand and financial "deleveraging."

Wang Qing, the chief macro analyst at Orient Gold & Credit, believes that one reason for the unchanged MLF operation rate in June is that the long-end market interest rates have fallen significantly in the previous period, and the central bank has warned about interest rate fluctuation risks on multiple occasions; recently, the long-end market interest rates have stabilized, but they still deviate significantly downward from the policy interest rate center, coupled with the recent decline in loan interest rates, which may imply that the urgency to lower policy interest rates is not high at present.

It can be seen that in May, the average yield of one-year commercial bank (AAA-rated) interbank certificates of deposit (CDs) fell to 2.09%, which is significantly lower than the 2.50% MLF operation rate; entering June, as of the 14th, the average of this indicator was 2.05%, and as of June 14th, the yield of one-year AAA interbank CDs closed at 2.04%, with the spread between the same period MLF inverted to 46 basis points.Since May, loan interest rates have continued to decline. In May, corporate loan and personal housing loan interest rates were around 3.7% and 3.6%, respectively, with year-on-year decreases of more than 0.2 and 0.5 percentage points.

The neutral interest rate is also a perspective for measuring the level of interest rates. The neutral interest rate refers to the interest rate level at which the economy achieves potential output and target inflation, which can be colloquially described as the interest rate level under an environment where the economy is neither too hot nor too cold. The neutral interest rate is a real interest rate and serves as a theoretical standard for assessing the stance of monetary policy. If the real policy interest rate, after deducting inflation factors, is lower than the neutral interest rate, it indicates that the support from monetary policy is relatively strong.

The academic community estimates China's neutral interest rate based on different assumptions, with the mainstream view suggesting that the current neutral interest rate level is around 2%. This year, the People's Bank of China has maintained the 7-day reverse repo rate in the open market operations at a relatively low level of 1.8%. After considering inflation factors, the actual policy interest rate is less than 2%, still below the neutral interest rate, and monetary policy continues to provide solid support for the real economy.

It should be noted that the recent low volume of Medium-term Lending Facility (MLF) injections does not signal a contraction in quantity. "The main reason is that the current wholesale financing cost in the money market for banks is significantly lower than the cost of financing through MLF from the central bank," said Wang Qing.

Wen Bin, Chief Economist at China Minsheng Bank, also stated that the interbank certificate of deposit (CD) rate is still at a low level, and the spread between MLF and CD rates has widened. Financial institutions have a weak demand for MLF, and reducing the volume of MLF continuations helps maintain market supply and demand balance.

Current interest rate cuts face internal and external constraints.

Although the market previously had certain expectations for an MLF rate cut in June, current interest rate cuts face internal and external constraints.

This year, the central bank has repeatedly stated publicly that there is still room for monetary policy, but the effects of previous policies are still being manifested, and future counter-cyclical adjustments will continue to be made in line with changes in the situation. Objectively speaking, further rate cuts face "dual constraints" from both internal and external factors.

Internally, industry insiders claim that the net interest margin of banks continues to narrow. By the end of the first quarter of 2024, the net interest margin of commercial banks in China had further decreased by 15 basis points to 1.54% compared to the end of the previous year. Profits are an important source for banks to replenish capital at present, and the continued narrowing of the net interest margin will affect the banks' ability to sustainably serve the real economy. Guiding deposit interest rates downward can moderately slow down the speed of the narrowing net interest margin, but it will also affect consumer spending on the residential side, and it is also necessary to guard against non-standard practices such as manual interest supplementation.

In fact, against the backdrop of the banking industry's regulation of manual interest supplementation, the originally "inflated" deposit interest rates will return to normal, which is also equivalent to a decline in the cost of bank deposit liabilities. Considering the factor of repricing after the maturity of existing term deposits, the effects of the previous downward movement of deposit interest rates are still continuing to manifest.From an external perspective, the exchange rate of the Chinese yuan is also a factor that needs to be considered. Since the beginning of 2023, the interest rate differential between China and the United States has continued to invert, putting the yuan exchange rate under depreciation pressure. Data shows that from January to May 2023, when the interest rate differential of the 10-year Treasury bonds between China and the U.S. was inverted by 100 basis points, the yuan-to-US dollar exchange rate remained around 7; at the beginning of 2024, the inversion widened to 180 basis points, and the yuan-to-US dollar exchange rate depreciated to around 7.2; currently, the interest rate differential inversion between China and the U.S. has reached 220 basis points, and it is not easy for the yuan-to-US dollar exchange rate to continue to remain around 7.2. Market experts analyze that interest rate adjustments also need to consider the impact on the exchange rate.

Wen Bin stated that currently, the market expects a higher probability of the Federal Reserve's first interest rate cut in September, but there is still strong uncertainty, and even after the rate cut begins, high interest rates will be maintained for a longer period. In addition, the cautious attitude towards inflation is not limited to the Federal Reserve. After the European Central Bank decided on its first interest rate cut, the recent speeches of European Central Bank officials have clearly turned hawkish. The CPI in France and Germany showed an upward trend in May, and the next stage of European inflation may enter a neutral range.

"Under this background, the constraints of overseas monetary policy on domestic easing are still significant, and it is necessary to wait until the policy clearly shifts direction to have a more appropriate timing for adjustment," said Wen Bin.

There is still room for reserve requirement ratio cuts and interest rate cuts.

Based on the better-than-expected economic growth in the first quarter, the macro data in the second quarter fluctuated significantly. In May, the consumer price index increased by 0.3% year-on-year, fell month-on-month, and was slightly lower than expected. In May, the PPI decreased by 1.4% year-on-year, and the decline narrowed significantly.

From a comprehensive market analysis, the current overall situation is in a period of observing policy effects. This is also a background for the recent stability of the MLF operation interest rate. Considering that for a period in the future, the price level will still be relatively low, and the momentum of economic growth needs further improvement, reducing the MLF operation interest rate in the third quarter is still one of the important policy options.

Zhou Maohua, a macro researcher at the financial market department of Everbright Bank, said that consumption and domestic demand maintain a recovery trend, but there is a lack of effective demand, an imbalance between supply and demand, a relatively low price level, some industries face recovery difficulties and challenges, and the impact of real estate on the recovery of domestic demand is still significant. Domestic macro policy needs to maintain strength and patience, there is still room for reserve requirement ratio cuts and interest rate cuts, but the policy needs to balance multiple goals, and policy tools should be used flexibly.

Dong Ximiao, the chief researcher at China United Financial, believes that although the current market liquidity is reasonably sufficient, it is still necessary to implement a comprehensive reserve requirement ratio cut in a timely manner. The reserve requirement ratio cut will play a positive role in three aspects: first, injecting medium and long-term liquidity into the market; second, promoting banks to maintain a basically stable interest spread and profit growth; third, conveying a clear signal of stable confidence and boosting expectations to the market.

"The necessity of using total quantity tools is still there, and monetary policy will continue to be loose," Wen Bin believes that as internal and external constraints gradually ease, the pace of monetary policy relaxation in the second half of the year may accelerate, and there is still room for reserve requirement ratio cuts and interest rate cuts to be implemented.

Wen Bin analyzed that the interest rate cut window is expected to open in the third quarter. On the one hand, since the beginning of this year, exports have played a significant role in driving China's economy. If external demand weakens significantly in the second half of the year, it will be necessary for a new round of monetary policy efforts. On the other hand, given that the current pressure of insufficient domestic demand is still there, and the willingness of residents to increase leverage has not seen significant improvement, it is also necessary to further stimulate credit vitality through adjustments in "price".The conditions for interest rate cuts are gradually accumulating. Since June, the pace of interest rate cuts by major economies has accelerated, with the Bank of Canada and the European Central Bank successively announcing rate cuts, indicating a global trend towards monetary policy easing; at the same time, the market's expectations for interest rate cuts by the Federal Reserve within the year have become increasingly clear, which will relatively alleviate the pressure to stabilize exchange rates compared to the previous period.

In addition, the effects of stopping "manual interest supplementation" are becoming more apparent, and the net interest margin of the banking system may be significantly boosted in the second quarter.

Wen Bin believes that going forward, to consolidate the stability of economic operations, there is still a need for fiscal policy to exert greater effort. Looking at the estimated net financing amount of government bonds, the liquidity pressure from May to October is manageable, but from November to December, due to the lower volume of government bond maturities, the liquidity pressure will relatively increase. Also, considering that the maturity volume of MLF (Medium-term Lending Facility) in the fourth quarter is the highest, it is possible that a reserve requirement ratio cut may be implemented at the end of the third quarter or in the fourth quarter to protect liquidity and alleviate the pressure on the central bank to continue with MLF operations.