The prices of commodities such as crude oil and iron ore may stay subdued, even after China's latest quarter percentage point cut in interest rates as the 6.3% lending rate is well above the 2008-2010 economic recovery level of 5.31% and analysts fret that the first cut in more than three years signals China's worries of more economic weakness this year.
"We expect commodities to continue to weaken over the near-term European debt crisis turmoil, a weak China, lower-than-expected growth in the US and no monetary 'shock and awe' from the Fed as the key reasons," TD Securities head of commodity strategy Bart Melek said last week.
"As such, commodity prices can continue to decline even as policy rates drop. In fact, this is exactly what has been happening historically, through Chinese easing cycles."
While the Chinese economy is not in a crisis, further monetary easing could take place in the second half of this year, another TD Securities analyst said. The analyst expects to see further cuts of 150 basis points in the reserve ratio as well as two more 25 basis point cuts to the key policy rates later this year, to levels near late 2010 rates.
The People's Bank of China, the central bank, cut the benchmark one-year lending rate and the one-year deposit rate by 0.25 percentage points last Thursday. The one-year yuan lending rate will stand at 6.31%, while the one-year yuan deposit rate will be 3.25%.
Crude futures, however, rallied over the weekend, buoyed by Sunday's economic data from China.
At 0606 GMT, July NYMEX crude futures were $86.20/barrel, up $2.10/b (2.50%) from Friday's settle, while July ICE Brent crude futures were $2.12/b higher (2.13%) at $101.59/b.
A drop in the domestic interest rate is also expected to bring about an increase in the rate of investment, as costs such as capital expenditure is reduced.
CHINA'S INTEREST RATES IN 2008-09, LOWEST SINCE 1996
During the previous recession in 2008-09, China's interest rates stayed flat at around 5.31% between December 2008 and October 2010, which coincided with a rally in crude and iron ore prices.
In the fourth quarter of 2008, China's central bank had aggressively lowered the rate five times in to sustain economic growth as it tried to combat the impact of a financial meltdown caused by a massive credit crunch in the US.
During that period, Dated Brent prices -- which are used as a pricing basis for two-thirds of the world's crude oil supply -- recovered some $47.12/b over February 2009-October 2010.
Dated Brent prices dipped to a low of $39.67/b on February 18, 2009, while they were at a high of $86.79/b on April 26, 2010.
The benchmark IODEX 62% FE CFR North China also saw similar rise in prices over February 2009-October 2010, with the benchmark index jumping $127.50/mt. Iron ore prices dipped to a low of $57.50/mt on March 20, 2009, while they jumped as high as $185/mt on April 4, 2010.
Monetary growth policies or two quantitative easing programs by the US between January 2009 and January 2011 also boosted sentiment and helped support the prices of both commodities.
MAY IMPORT, EXPORT DATA OF OIL AND IRON ORE BEATS EXPECTATIONS
The world's number two energy consumer, imported a record 25.48 million mt, or about 6 million b/d of crude oil in May, up 18.2% from a year ago, General Administration of Customs data released Sunday showed.
This averages to a record 6.02 million b/d and surpasses the 5.98 million b/d imported in February this year.
The spike in China's May oil imports could have been spurred by lower crude prices last month. According to Chinese data, the value of May crude imports stood at $22.36 billion or an average $877.53/mt, compared with $901.54/mt in April.
Crude exports in May jumped 260% year on year to 180,000 mt. This puts net crude imports at a record 25.3 million mt (5.98 million b/d) in May, up 17.7% year on year and 13.9% month on month.
Oil product imports in May rose 2.4% to 3.47 million mt while oil product exports dropped 15.5% to 2.08 million mt. Net oil product imports were up nearly 50% year on year to 1.39 million mt although this was only a 2.2% increase from April's 1.36 million mt.
Meanwhile, iron ore imports by China, the world's biggest buyer, jumped 19.8% year to 63.84 million mt in May. Iron ore imports in May were up 10.7% from 57.69 million mt in April. The value of May iron ore imports stood at $9.01 billion or an average $141.16/mt, compared with $138.83/mt in April.
"Viewing China's May data as a whole, we believe the economy is still weak, but policy loosening ... should help boost growth in the second half 2012," Nomura said in a report published Sunday.
CHINA'S NDRC CUTS DIESEL, GASOLINE PRICES
In what could be seen as an attempt to spur growth for the world's second largest economy in the short-term, China's National Development and Reform Commission said late Friday it will lower retail prices of gasoline and diesel by Yuan 530/mt ($83.25/mt) and Yuan 510/mt ($80.11/mt), respectively, starting from Saturday.
This is the deepest price cut since December 2008 -- when prices for both products were reduced by over Yuan 1,000/mt -- and is a reflection of the slide in international crude prices in recent weeks.
IRON ORE PRICES STEADY SINCE RATE CUT
Steel mills, which use iron ore as a core steelmaking ingredient, generally see lower interest rates as an incentive to encourage more borrowing in order to finance steel production, in the hopes that downstream sectors would see a boost in steel demand.
"Lower interest rates will boost the Chinese property market as the loan rate was too high in the past. Lower rates will stimulate property and thus all related industries -- iron ore, coking coal, and steel -- will be advanced," a source at a state-owned Chinese iron ore trading house said.
A drop in the interest rate would spell "good news for industry players, with steel mills benefiting the most as construction and real estate projects would find some support there," a Guangzhou-based trader said.
"But it will take some time for any impact from the cut in interest rates to be reflected ... As of now, we won't see any immediate outcome, but it has definitely improved the general outlook," he added.
Between 1996 and 2012, China interest rate averaged 6.46% reaching an all-time high of 10.98% in May 1996 and a record low of 5.31% in August 2010, according to data from tradingeconomics.com.
