PBOC acts after manufacturing figures show contraction looming

China has cut benchmark interest rates for the first time since July 2012 in an effort to prop up growth as the economy continues to slow.

Effective from Saturday, the one-year benchmark lending rate will be lowered by 40 basis points to 5.6 percent and the one-year benchmark deposit rate by 25 basis points to 2.75 percent, the People's Bank of China said on Friday.

The adjustment comes after figures showed that manufacturing activity in the country is nearing a contraction.

"It's absolutely the right thing to do," said Wang Tao, chief China economist at UBS AG in Hong Kong, China. "Real interest rates have moved up significantly with slowing growth and inflation, which hurts corporate cash flow and balance sheets and threatens to increase nonperforming loans."

Some economists and market insiders have been looking for interest rate cuts for some time. But others were surprised by the change because the People's Bank of China, the central bank, is reluctant to use rates to boost the economy for fear of fueling a credit bubble.

Andrea Tueni, a trader at Saxo Bank in Paris, said: "This shows that they are increasingly concerned about the economic outlook. It's also a strong signal, because it shows that they are determined to reverse the recent slowdown in growth."

The cut in benchmark rates follows liquidity injections and targeted reductions to reserve requirements.

But it does not mean a change of direction for China's monetary policy, as the economy is still operating within a reasonable range, the central bank said in a statement on its website.

Xiang Songzuo, chief economist at Agricultural Bank of China, said: "The Chinese economy is still maintaining relatively fast growth. There is no need for the government to roll out strong stimulus measures.

"The central bank is sticking to and improving the mechanism for interest rate adjustment by using interest rate tools flexibly to fine-tune the economy."

Xiang said the reduction will take interest rates to a reasonable level and also provide a neutral and moderate monetary policy environment for sustainable development of the economy.

Lu Zhengwei, chief economist at Industrial Bank, said, "The cut will help to lower financing costs systematically at the start of next year, especially those for small businesses, the farming sector and real estate sector."

The central bank also freed up deposit rates, allowing banks to pay depositors 1.2 times the benchmark level, up from 1.1 times.

Lu said the increase will lay the foundations for a full liberalization of interest rates and also avoid difficulties in attracting deposits.

The central bank said it will pick the right time to issue large certificates of deposit to companies and individuals, continue to push forward the marketization of deposit rates, and improve its ability to regulate interest rates as well as the macroeconomy.

Reuters contributed to this story.