China's central bank introduces new tool to manage liquidity and interest rates

On Monday, China's central bank rolled out a new policy tool to manage liquidity and interest rates more effectively within the banking system.

The instrument represents temporary bond repurchase agreements and reverse repos by setting interest rates that are going to influence short-term borrowing costs.

Analysts believe that this would pave the way for a new interest rate corridor setting, with the seven-day reverse repo rate acting as a benchmarking for short-term interest rates.

Indeed, PBOC Governor Pan Gongsheng hinted earlier that the seven-day rate was already, de facto, much like a key policy rate.

The temporary repos and reverse repos would be short-term loans with a one-day maturity. The PBOC will decide whether to conduct repos or reverse repos based on market conditions.

Interest rates for such temporary agreements are set at 20 basis points below and 50 basis points above the seven-day reverse repo rate, translating to 1.6 per cent and 2.3 per cent respectively.

The step, according to analysts, "will give the PBOC the flexibility to fine-tune liquidity conditions by injecting cash through reverse repos or draining excess funds through repos."

Interest rate asymmetry, said market participants, was thought to deter excessive borrowing and also had the potential to turn into a formal policy tool in the future because of its higher rate for borrowing than lending.

Analysts say the PBOC is likely to conduct such temporary operations strategically, especially at month-ends or quarter-ends, when liquidity may need more managing.

While the response of the Chinese bond market was limited, with some pickup in yields, other analysts see that this PBOC move signals—possibly having the effect of—coolly bonding the market by tightening liquidity.

This is amid the recent comments by the PBOC about tapping a large pool of bonds for sale at any time.

(With inputs from Reuters)