China’s Central Bank Takes More Control Over Rates by Adding Temporary Repos

 

 

The People’s Bank of China acted to take more control of market interest rates, announcing additional open market operations and tightening the band within which short-term rates can fluctuate.

The central bank will conduct bond repurchase or reverse repurchase operations in the afternoon as needed, in addition to its traditional morning operations, according to a statement on Monday. The price will be based on the seven-day reverse repurchase rate, strengthening it as a benchmark policy rate.

PBOC Governor Pan Gongsheng hinted last month that the bank would reform interest rate policy as it seeks to bolster growth in the world’s second-biggest economy while keeping the yuan stable. Pan suggested the bank would narrow the interest rate corridor within which market rates are allowed to fluctuate to indicate a clearer policy target, and also signaled the bank would consider moving to using a single short-term rate to guide markets.

The additional open market operations will be conducted from 4 p.m. to 4:20 p.m. on weekdays as needed, the PBOC said 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.

This effectively narrows China’s interest rate corridor from about 230 basis points previously to 70 basis points now, said Becky Liu, head of China Macro Strategy at Standard Chartered.

“It will lead to a reduction of interbank rate volatility,” Liu said. With lower volatility, the seven-day reverse repo rate “will be used more widely as a benchmark reference rate across most assets and liability pricing across deposit rates and loan rates.”

The latest announcement comes shortly after the PBOC said it would borrow government bonds from primary dealers, a sign 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 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.

“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.”

--With assistance from Felix Tam and Cormac Mullen.