UPDATE 1: The Chinese central bank unexpectedly cuts interest rates to prop up the flagging economy

(Adds analyst comments)

SHANGHAI/SING`ORE, Aug 15 (Reuters) – China’s central bank surprisingly cut interest rates for the second time in three months on Tuesday. This is a fresh sign that the authorities are stepping up their monetary easing efforts to boost a faltering economic recovery.

Analysts said the move opens the door to a possible cut in China’s prime lending rate (LPR) next week.

Slowing credit growth and rising risks of deflation in July required further monetary easing to halt the slowdown, market watchers said, while default risks at some property developers and a default by a private wealth manager also weighed on financial market confidence.

“All of this increases the urgency that policymakers must act quickly before consumer and business confidence plummets,” said Tommy Wu, senior China economist at Commerzbank.

The People’s Bank of China (PBOC) said it raised the interest rate on 401 billion yuan ($55.25 billion) one-year medium-term lending (MLF) facilities to some financial institutions by 15 basis points, to 2.65% from a previous 2.65% .50% reduced .

The cash injection was intended to counteract factors such as tax payments to “keep the liquidity of the banking system reasonably adequate,” the PBOC said in an online statement.

In a Reuters poll of 26 market watchers conducted this week, 20 participants, or 77%, predicted the central bank would leave the MLF rate unchanged. Only six respondents forecast a small tariff reduction.

“The surprise rate cut was a quick reaction to support from muted credit data and China’s recovery, which could trigger depreciation pressures in the yuan towards 7.3,” said Ken Cheung, chief Asian foreign exchange strategist at Mizuho Bank.

“In particular, the PBOC may intend to support medium-term credit conditions through the asymmetric cut and has paved the way for a cut in the LPR, particularly the 5-year LPR, to support the troubled real estate sector.”

The story goes on

The MLF rate serves as a guide to the LPR and markets tend to use the medium-term policy rate as a precursor to any changes in credit benchmarks. The monthly determination of the LPR is due next Monday.

The central bank also injected 204 billion yuan via seven-day reverse repurchase agreements while reducing borrowing costs by 10 basis points to 1.80% from the previous 1.90%, an online statement said.

China remains a special case among global central banks as the country has eased monetary policy to shore up the sluggish recovery while other banks have been on tightening cycles to battle high inflation.

Tuesday’s rate hike has widened yield differentials with other major economies, particularly the United States, putting more pressure on the yuan and risking outflows.

China’s yuan has lost about 5% against the dollar so far this year, becoming one of the worst-performing currencies in Asia. The yuan was trading at 7.2842 per dollar by 0145 GMT compared to the previous close of 7.2580.

China 10-year government bond yields fell to 2.56%, the lowest since May 2020.

The PBOC cut interest rates in June to prop up the broader economy, but the data has weakened since then. ($1 = 7.2585 Chinese Yuan) (Reporting by Winni Zhou and Rae Wee; Editing by Kim Coghill and Jamie Freed)