Market sentiment could be boosted by the move by Chinese authorities to bring down the amount of funds banks need to hold in reserve, and it could also be beneficial for stocks in some sector, said a report from the investment bank UBS.

Reduction of the reserve requirement ratio (RRR) by 50 basis points for all banks was announced recently by the People’s Bank of China (PBOC) and this change is applicable from July 15. Analysts at UBS expect this move to increase long term liquidity in the market and the economy by about 1 trillion yuan (or $154 billion).

In the banking industry, the reserve requirement is the amount of funds that banks need to keep in reserve as a proportion of their total deposits. When the requirement is reduced banks have more money that they can infuse into the economy through lending to businesses and individuals.

“We think this broad-based RRR cut could boost market sentiment in the short term and improve stock market liquidity,” UBS analysts Lei Meng and Eric Lin said in a note on Monday.

According to UBS, liquidity sensitive sectors, such as aerospace and defense, electronics, IT and media, could get a boost in the short term by the move.

UBS said that companies that have strong earnings expectations could also outperform and pointed out to sectors such electric vehicles and batteries as well as the new energy sector. However the bank also indicated that growing concerns over the slowing growth in Chinese economy could make the rally in the market short lived.

“The RRR cut has, to some extent, added to equity investors’ concerns that the economic recovery in Q2-Q3 (this year) may not be as good as the market expected,” the UBS analysts wrote. “In our view, in the absence of a directional shift to monetary policy loosening, the additional liquidity will not drive a sustained market rally.”

UBS analysts said that the latest move by the PBOC delivers a signal that Chinese authorities are acknowledging the growth risks being faced by the Chinese economy.

 “It is a signal, it’s a higher profile message I think, that the authorities are paying attention and alert to the possibility of downside risks,” Andrew Tilton, chief Asia Pacific economist at Goldman Sachs, said on Monday.

“The move, which is expected to inject 1 trillion yuan into the economy, is an acknowledgement of strong headwinds to corporate profitability, financial stability, and growth,” said Eurasia Group analysts in a separate note.

Vishnu Varathan, head of economics and strategy as at Mizuho Bank in a note on Monday that the Chinese move “does not detract from PBOC’s ‘prudent’ monetary stance that’s done with emphatic easing”.

The focus is on calibrating credit which entails reducing credit to calibrating credit while increasing lending for small- and medium sized companies, he added.

The core of the policy of China is still focused on mitigating a build-up of financial stability risks, said Varathan.

(Adapted from CNBC.com)