Chinese policy makers are holding back from rolling out the big guns of monetary stimulus, keeping options in reserve as the trade stand-off with the US risks morphing into a global currency war.

The People’s Bank of China, on late Friday, called for a rational view on current headwinds, signalling that the targeted approach to shoring up output would continue. Investment, retail sales and credit data due this week are expected to confirm the ongoing slowdown in the worlds second-largest economy.

Officials are sticking to a cautious monetary strategy even after tensions with the US worsened, with President Donald Trump’s accusations of Beijing’s currency manipulation, adding sensitivity to any stimulus measures that would depress the yuan. At the same time, the weakening of the currency past 7 per dollar removes one barrier for a cut to interest rates, should the trade war deteriorate to the point where stronger action is needed.

“Policy makers are fine with the current state of the economy,” said Larry Hu, head of China economics at Macquarie Securities Ltd in Hong Kong. “But if growth continues to slow, at certain point, the priority will shift to growth stabilisation.”

Deepening confrontation

Former central bankers gathered for a policy symposium in the far North East warned on Saturday that the confrontation with the US is deepening.

“The US’ labelling of China as a currency manipulator signifies the trade war is evolving into a financial war and a currency war, and policy makers must prepare for long-term conflicts,” Chen Yuan, former deputy governor of the People’s Bank of China, said at a China Finance 40 meeting in Yichun, Heilongjiang.

Former PBOC Governor Zhou Xiaochuan called for efforts to improve the yuan’s global role to deal with the challenges of a dollar-denominated financial system.

The challenges are not just from the dollar. In its annual report (released on Friday) on the Chinese economy, the International Monetary Fund said that if the US escalates its current threat to add 10 per cent extra tariffs on the remainder of its imports from China to 25 per cent, growth would be trimmed by 0.8 percentage point, leading to significant negative spillovers globally.

“It is in that kind of scenario that China may be forced to turn to more aggressive monetary support, even in the face of rising domestic debt risks and asset price bubbles. Efforts to prop up growth have already propelled the stock of corporate, household and government debt to more than 300 per cent of Gross Domestic Product,” according to an Institute of International Finance report last month.

Nevertheless, having allowed the yuan to weaken past 7 per dollar, the PBOC has freed itself from an artificial constraint that it has been bound by for years, allowing borrowing costs to be reduced further without, in theory, the need to prop up the currency.

What Bloomberg’s economists say

In our view, the PBOC will cut benchmark interest rates in the coming months. The near-term risk is obvious, including increased market volatility and pressure for capital flight. Our view, though, is that the PBOC has the capacity to prevent currency depreciation from getting out of hand.

-- Qian Wan and David Qu, Bloomberg Economics

So far, policy makers have not given any hint of changes to the 1-year lending rate which would affect the price of borrowing across the whole economy, or reducing the price of loans to banks in the wake of the US Federal Reserves latest cut. Instead, officials from PBOC Governor Yi Gang downward have signalled that an impending reform of the interest rate system could do the work of a rate cut, by transmitting policy more effectively.

In the meantime, China’s leadership appears to want to manage the economy’s long-term slowdown rather than arrest it, and smooth shorter-term weakness in consumption and output with about 2 trillion yuan ($283 billion) in tax cuts, as well as localized investment incentives.

Auto sales, about one quarter of reported offline retail consumption, resumed contraction in July, data released last week show. Infrastructure investment will likely pick up marginally, and credit growth is under pressure as property financing tightens and local governments finish bond sales.

An objective and rational view should be taken on those headwinds, the PBOC said in the report released Friday evening. The central bank should stay confident, be focused, mind our own business, and use a combination of tools to form new growth drivers, it said.

Targeted reductions in the amount of money banks park at the central bank and use of medium-term loans to ease funding constraints are likely to continue. Above all, with domestic monetary policy unchanged, the yuan’s dip to 7.1 to the dollar could, if sustained, essentially absorb the impact of Trump’s latest tariff increase, according to China Merchants Bank Co.

“Stability is still the focus with quality growth, and the employment market more important than GDP,” said Jeff Ng, chief Asia economist at Continuum Economies in Singapore. “China will allow a slowdown and is prepared to do so.”