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The People's Bank of China reduced the amount of money banks must hold by about CNY350-CNY400 bln (~$60 bln). It is a 50 bp reduction in the required reserve ratio (NYSE:RRR), effective May 18. It is the third cut in six months. The precise timing is always impossible to predict, but it was widely expected.

In fact, two consideration was behind our warning that it was coming soon. First, China reported soft economic data 24 hours before the RRR cut was announced. The disappointing economic data included weaker than expected industrial production (slowed rather than increased) and fixed asset investment, which is an important engine of China's growth, which continued to slow and now is growing at its slowest pace in nearly a decade.

The dramatic slowing of new yuan loans was also part of the data dump on Friday May 11. In March Chinese banks made CNY1.01 trillion of new loans. In April the pace slowed to about CNY682 bln. Economists had expected a slowing, but not as much as actually took place.

The second consideration is this -- habit may be too strong of a word -- frequent pattern of China's to take some action prior to high level meetings. Recall China's recent decision to widen the allowable band for the dollar-yuan rate to 1.0% from 0.5% took place on the eve of an IMF meeting and shortly before a round of US-China Strategic Economic Dialogue meetings. There is a G20 meeting May 17-18.

The soft-landing view of China, which seems to be the market's base case (of course there are other voices but they seem to be in a distinct minority), is really two calls. First, that the economy slows but not too much or too fast. It has slowed for five quarters to 8.1% in Q1 '12, a still healthy growth rate by any metric. Second, that it lands. That it stops falling. This has yet to take place and after Friday's data, several economists cut their forecasts for Q2 GDP.

The RRR will stand at 20.0% when the 50 bp cut is implemented for large banks. Many observers expect at least two more RRR cuts this year. The first cut came in Nov '11 and the second one in February. With this cut in May, the PBOC's pattern, if you will, is every cut every three months in this cycle. That suggests the next one is in August. However, if the data continues to disappoint, and its largest export market, Europe, remains in crisis, another RRR sooner would reflect increased concern by officials.

Insofar as the RRR cut seems reactive in nature, it is unlikely to turn the tide in sentiment. The April bounce in the Shanghai Composite appears complete. It closed below the 20-day moving average on Friday for the first time in a month. The 12-month NDF of the yuan is still pricing in some depreciation this year. Since China is perceived to be the key driver for many industrial goods, the lack of a a bounce in its economy is a weight on commodity prices.

Source: China Cuts Required Reserves