China’s central bank has limited firepower to halt a deflationary slide

Reports that Chinese regulators asked certain commercial lenders to reduce exposure to US Treasuries prompted an immediate market reaction: the dollar softened against the onshore yuan and US government bond prices swung as traders reassessed reserve flows. That episode highlights a familiar policy dilemma for Beijing. Domestic demand remains weak after a prolonged property slump and constrained household spending, reducing the transmission of conventional monetary easing into inflation and growth. The People’s Bank of China retains operational levers — lower lending benchmarks, short‑term liquidity provision and targeted measures — but those tools face diminishing returns when confidence and private demand are impaired. Recent moves to nudge credit conditions looser (including cuts in bank lending benchmarks) demonstrate tactical easing, yet without complementary fiscal support and credit‑channel repair their impact on aggregate demand is likely muted. At the same time, authorities are managing a delicate FX strategy: a push to broaden renminbi use and expand onshore‑offshore links sits alongside deliberate exchange‑rate management that narrows policy space for large‑scale reserve changes. Any sizeable shift away from dollar assets would reverberate through global bond markets and could force other central banks to adjust positions, so Beijing’s reserve management decisions are being weighed against potential international spillovers. Episodic sources of FX pressure — from cross‑border tourism reopenings to wider global rate repricings — add noise and raise the cost of repeated intervention, since sterilising operations can sap domestic liquidity or erode reserves. Beijing’s habit of orchestrated market support in equities and credit markets adds another constraint: state‑linked buying stabilises sentiment but increases contingent fiscal and balance‑sheet liabilities, reducing room for aggressive macro stimulus. The likely outcome is a drawn‑out period of subdued inflation with intermittent market turbulence: Beijing can mitigate acute disruptions, smooth intraday volatility and lower borrowing costs selectively, but it lacks a clean, rapid mechanism to reverse a deeper deflationary trend without creating currency, capital‑flow or financial‑stability side effects.