MNI: PBOC Repos First Step To Narrower Rates Corridor-Advisors

The People’s Bank of China’s new overnight repo facilities are aimed at limiting short-term liquidity volatility as it prepares to trade bonds in an attempt to steepen the yield curve, but are also a step towards narrowing the interest rate corridor, policy advisors and economists told MNI.

The PBOC announced temporary overnight repo and reverse repo operations on Monday, saying it will conduct them at rates 20 basis points lower and 50bps higher than the 1.8% seven-day reverse repo. This sets a 1.6%-2.3% range for the rates of overnight wholesale funds, and strengthens the role of the seven-day reverse repo rate as a reference to short-term interest rates, in line with comments last month by PBOC Governor Pan Gongsheng, said Ming Ming, chief economist at CITIC Securities and a former PBOC official.

The central bank is likely to perform the overnight operations, to be conducted from 16:00 to 16:20 pm Beijing time on trading days as needed, at mid-month, end of month and end of quarter when liquidity usually suffers pressure, said Ming.

An advisor familiar with policy operations told MNI the new reverse repo tool aims at limiting disruptions during PBOC sales of treasury bonds, the first of which may be conducted after the Communist Party’s third plenary session next week.（SeeMNI: PBOC Eyes CGB Selling To Curb Bull Bond Market）

The Bank’s first use of a repo in 10 years and operations in the afternoon trading session show it wants more precise control of liquidity, he said, and while its initial motivation is to address depressed long-term yields, in the longer run the tools will help structure a framework for more regular PBOC bond transactions and define a narrower interest rate corridor as the authorities tackle high liquidity and soft credit demand at a time of economic transition.

From now on the overnight rate and not the one-year medium-term lending facility rate will define the corridor together with the seven-day rate, the advisor said, adding that this was more in line with global practice. The one-year MLF rate has proven increasingly less effective in guiding the loan prime rate, which reflects commercial lending rates. (See MNI PBOC WATCH: LPR Reduction Eyed, MLF Downgrade Next)

SHORT-TERM RATE CONTROL

The PBOC is focusing on short-term rates as the most effective guide for money markets, according to Cao Jing, associate research fellow at the Chinese Academy of Social Sciences’ Institute of Finance and Banking. Meanwhile, PBOC bond trading is aimed at enhancing coordination between liquidity injections and fiscal expansion, updating the monetary framework, said Cao. (See MNI INTERVIEW: PBOC Can Use QE Strategically If Necessary - Yu)

The PBOC currently uses “window guidance” to prompt big banks to unlock funds in the interbank market during liquidity crunches, so its new tools will make its liquidity management more transparent, a Beijing trader told MNI

Currently China’s interest rate corridor ranges from the 2.8% ceiling set by the standing lending facility to a floor of 0.35% for interest on excess reserves. But, Cao noted, financial institutions have shown limited interest in borrowing from the SLF, so it is failing to set a realistic ceiling, with interbank rates remaining well below it, while the interest on excess reserves is too low, meaning that funds remain stuck in the banking system and monetary policy becomes less effective.

INTEREST-RATE CORRIDOR

However, some economists argue the new arrangements are only a step towards a more durable and narrower corridor, rather than a permanent floor and ceiling of 1.6% to 2.3%.

CF40, a well-known think tank, said in a research note that the repo and reverse repo operations are unsuited for setting a corridor, as the timing and magnitude of their deployment is at the PBOC’s discretion rather than decided according to banks’ funding needs. Similarly, they are not available to smaller banks and non-banks, which are most vulnerable to liquidity shortages.

Nor is the PBOC’s move likely to reverse the bond rally, which has led officials to worry that banks might be exposed in the event of a market reversal, the trader said. While the repos and treasury sales will possibly cause a temporary yield curve steepening, weak credit demand and China’s struggling properly market will persist, meaning that yields will soon continue their downward trend, he added.