China’s central bank takes more control over rates by adding temporary repos
THE People’s Bank of China (PBOC) tightened its grip on interest rates, introducing a new mechanism to influence short-term borrowing costs as policymakers expand their toolkit to guide markets.
The central bank’s move to conduct new bond repurchase or reverse repo operations effectively narrows the corridor within which short-term rates can fluctuate. That will strengthen market expectations for the seven-day repurchase rate to become the new benchmark.
PBOC Governor Pan Gongsheng has been taking greater control of market liquidity and borrowing costs across the yield curve this year. On top of signalling the bank’s preference for a single short-term rate, policymakers have flagged that the PBOC is preparing to cool a bond rally by selling longer term securities, as investors pile into safe assets prompting fears of a bubble.
The PBOC’s latest policy move helped push up benchmark 10-year bond yields to their highest since May on Monday. The central bank didn’t announce that it had taken any additional market operations on Monday afternoon.
The additional open market operations will be conducted from 4 pm to 4.20 pm on weekdays as needed, the PBOC said on Monday. The term of the temporary repos and reverse repos will be overnight, and rates will be set at 20 basis points below and 50 basis points above the seven-day reverse repo rate, respectively.
The move is aimed at “ensuring reasonable and sufficient liquidity in the banking system and to improve the precision and effectiveness of open market operations”, the PBOC said.
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“This will give the PBOC more control over short-term rates and create greater flexibility to manage fluctuations in liquidity,” said Duncan Wrigley, chief China economist at Pantheon Macroeconomics. “If selling bonds results in overly tight short-term liquidity, the PBOC now has new tools to manage that, to prevent a liquidity crunch.”
“It effectively narrows China’s interest rate corridor, from previously nearly 250 basis points to 70 basis points,” said Becky Liu, head of China Macro Strategy at Standard Chartered. “It will lead to a reduction of interbank rate volatility.”
“With reduced volatility, this rate will be used more widely as a benchmark reference rate across most assets and liability pricing across deposit rates and loan rates,” Liu added.
The latest announcement comes shortly after the PBOC said it would borrow government bonds from primary dealers, a sign that it may be contemplating selling securities to cool a market rally and stop longer-term bond yields from falling. The bank moved closer to implementing that last week, saying on Friday that it now has hundreds of billions of yuan worth of securities at its disposal to borrow and would sell them depending on market conditions.
China’s sovereign bonds have surged this year on the back of the country’s gloomy economic outlook and expectations for interest rate cuts. The lack of attractive alternatives and a switch out of savings to financial investments has fanned demand. This led to a series of warnings from the PBOC on the risks of a bond bubble, particularly in longer-dated debt.
The new corridor around the seven-day reverse repo rate, which the central bank has singled out as the flagship policy rate, could signal a push to tighten control on the short-end of the yield curve, according to Bloomberg Intelligence (BI).
“With the PBOC also set to control the longer-end of the curve via Treasury bond trading, China might be essentially adopting yield-curve control,” BI analysts Stephen Chiu and Jason Lee wrote in a note. “Future rate cuts could be done via the seven-day reverse repo first.”
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