The preferred level for long-term interest rates is determined by the “neutral interest rate.” This rate is influenced by two key factors: the long-term economic growth rate and the long-term inflation expectation. If the target inflation rate is set at 0.6%-1.0% and the long-term economic growth rate is maintained at 5.0%, the nominal neutral interest rate would be between 1.60% and 2.0%. If long-term inflation remains low, the main policy interest rate could be cut by another 10 to 20 basis points. This would push long-term interest rates closer to the neutral policy interest rate level. As a result, the 10-year interest rate could decline, with its central level potentially dropping to between 1.30% and 1.40%.
From the perspective of the “neutral interest rate,” there is still room for further interest rate cuts to adapt to low long-term inflation expectations. Currently, the actual neutral interest rate is 1.40%, which matches the 7-day reverse repo rate after the interest rate cut in May. However, given that long-term inflation expectations remain low— with the average year-on-year CPI growth rate from February to May 2025 at -0.25%—the main policy interest rate should continue to be reduced. If this -0.25% CPI growth rate persists in the second half of the year, the main policy interest rate could be cut by another 10 to 20 basis points. This would further lower short-term interest rates and guide long-term interest rates toward the neutral policy interest rate level.
In a macroeconomic sense, long-term interest rates should gradually converge toward the neutral interest rate. Long-term yields, as an expectation of short-term interest rates, should also align with the neutral interest rate. The transmission mechanism is “main policy interest rate → short-term interest rate and expectations → long-term interest rate.” Since inflationary pressure began to ease in the second quarter of 2023, the GDP deflator has been negative for eight consecutive quarters by the end of the first quarter of 2025.
The interest rate market has maintained high expectations for interest rate cuts, driving long-term interest rates closer to the policy rate and flattening the yield curve. Before the main policy rate drops to a level where inflation expectations significantly rebound, long-term interest rates may continue to approach policy rates. The short-term interest rate formed by the “7-day reverse repo rate → DR001” could become the floor for the 10-year Treasury bond yield. If the long-term potential growth rate is set at 5.0%, the actual neutral interest rate would be around 1.0%. The preferred level for long-term interest rates would then depend on long-term inflation expectations. If inflation remains low, the decline in long-term interest rates may continue.
The long-term interest rate “corridor” is taking shape. Since December 2024, when the logic of “reducing debt costs” pushed the 10-year interest rate below the DR007 “annual line,” the 10-year Treasury bond yield has gradually formed an “interest rate corridor.” The bottom of this corridor is the DR001 “annual line,” and the top is the DR007 “annual line.”
From the perspective of yield curve transmission, further declines in long-term interest rates require policy interest rates to guide short-term interest rates downward. After the “reserve requirement ratio cut and interest rate cut” in May 2025, the 250-day moving average of DR007 has been pushed down to 1.78%. This suggests that the upper limit of interest rates is also being lowered step by step. The 250-day moving average of DR001 has dropped to 1.64%, just 0.71 basis points away from the 10-year Treasury bond yield. DR001 and DR007 are likely to continue driving fluctuations in long-term bond interest rates.
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