Central bank most likely to cut RRR of financial institutions, says analyst

China's monetary authorities may moderately ease their overall prudent policy stance in the second half of the year, helping to anchor economic growth and the stock market, analysts said on Thursday.

Chinese stocks rallied on Thursday after the US Federal Reserve's dovish signal raised investors' expectation of more ample global liquidity.

The benchmark Shanghai Composite Index rose 2.38 percent to close at 2987.12 points, while the smaller Shenzhen index closed 2.34 percent higher at 9134.96 points on Thursday, with brokerages and companies related to environmental protection leading the rise.

The latest meeting of the Fed's policy-setting Federal Open Market Committee left its key interest rate unchanged, but signaled that it is prepared to start cutting rates, if this is required to shield the US economy from trade tensions and other threats.

After the meeting, Goldman Sachs Group Inc analysts released a report saying they expect the Fed to cut interest rates in July and September.

"In the long term, the Fed is expected to proceed with rate cuts in a fairly slow and smooth way," said Cheng Shi, chief economist of ICBC International.

This will enlarge the monetary policy room of other major economies and expedite the change toward an easing global monetary environment, which will in turn lift the sentiment of global stock markets, Cheng said.

Monetary authorities from both developed and developing economies have become more dovish this year, some of which－such as in India, New Zealand, Australia and Russia－have cut their interest rates. The European Central Bank said on Tuesday it is ready to provide further stimulus as well.

As for China, the wider policy room provided by the Fed's dovish tone－as well as this year's controllable inflationary pressure－is expected to trigger monetary easing measures in the second half of the year, said Zhang Yu, chief macroeconomic analyst with Hua Chuang Securities, based in Guiyang, Guizhou province.

China's consumer price index, the primary barometer of inflation, hit a 15-month high of 2.7 percent year-on-year in May, but Zhang expects inflation levels to fall in the third quarter as economic expansion weakens.

To offset downside risks and support credit expansion, the central bank is most likely to cut the reserve requirement ratios of financial institutions, she said. Such moves will reduce the amount of money banks keep in the vaults and therefore boost lending.

"In the short term, however, it may be unnecessary to cut interest rates," she added, citing that China's monetary policy is expected to remain prudent.

Zhang Jun, chief economist with Morgan Stanley Huaxin Securities Co Ltd, agreed that the central bank will refrain from the strong easing measure of interest rate cuts.

As there is still work to be done to improve monetary policy transmission mechanisms－or to funnel additional liquidity into the real economy, particularly small businesses and infrastructure investment, interest rate cuts may translate into asset bubbles, instead of stronger economic expansion, Zhang Jun wrote in a note.

"As China's economic fundamentals and policy stances do not totally synchronize with those of the US, it is necessary to improve China's macro policy independence, especially for monetary policy," Zhang Jun wrote.

Yi Gang, governor of the People's Bank of China, the central bank, told Bloomberg earlier this month that interest rates and reserve requirement ratios both have "plenty of room" for adjustment, but the monetary policy will remain "prudent" and should be "sober-minded".

In the near term, China's stock market may be pushed up by rising expectations of improved liquidity conditions and a restart of Sino-US trade talks, according to analysts from Guangzhou, Guangdong province-based GF Futures.

Also, the inclusion of A shares into FTSE Russell's global benchmarks will take effect on Friday, accelerating foreign capital inflows, the analysts said in a report.

However, investor sentiment may still be clouded by uncertainties, pending the meeting of leaders of the world's two biggest economies later next week during the G20 summit, analysts said.