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China’s central bank raises obscure rate to send clear message

An obscure interest rate reached between China’s central bank and lenders in a treasury fund auction has jumped, causing jitters in the onshore bond market on Monday and delivering a message that the People’s Bank of China is unwilling to provide limitless cheap funds to banks.

While the rate stuck between the PBOC and deposit-taking institutions on Monday is neither a policy one nor a benchmark money rate, the surge of 40 basis points from the previous deal shows that the PBOC is tightening the liquidity tap to cope with a weakening yuan, inflated property prices and possible rate increases by the US Federal Reserve.

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The PBOC’s move came as extreme monetary easing across the world is drying up and it is becoming increasingly clear that monetary policy alone can’t fix economic woes. The European Central Bank is reportedly discussing possible reductions in the pace of monthly bond purchases, and the Bank of Japan expressed concerns on Tuesday over risks of negative interest rates.

“China’s monetary policy is leaning towards tightening” as immediate slowdown pressures abate, said Larry Hu, a China economist with Macquarie in Hong Kong. “The PBOC is redirecting its focus to financial risks such as housing market bubbles.”

But it is still too early to say that the PBOC is changing its fundamental pro-growth stance, and any major tightening, such as an increase in benchmark policy rates, is still a remote possibility in the world’s second-largest economy, Hu said.

The PBOC has been refraining from major policy moves since its latest cut in the required deposit reserve ratio in March. Instead, the central bank has opted for less eye-catching open market operations and policy tweaks to control funds in the banking system.

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An overall accommodative monetary stance has helped factories and infrastructure projects raise funding, mitigating hard-landing risks. At the same time, with a comfortable 6.7 per cent headline growth rate in the first three quarters, the PBOC is turning more attention to housing market bubbles and excessive “leveraging” in bond trading.

On Monday, the PBOC’s auction of 80 billion yuan (HK$91.6 billion) treasury funds to commercial banks as three-month deposits were priced at 2.95 per cent, the highest level since May. China’s central bank has only held eight auctions so far this year, but the increase still made China’s bond investors nervous. China’s five-year sovereign debt futures for delivery in December declined 0.16 per cent, the largest drop since August 30, to 101.95 on Monday, and the most active 10-year contract dropped 0.27 per cent.

“The PBOC didn’t directly raise money market rates or policy rates … but the tight supply of liquidity is almost equivalent to an interest rate increase,” Deng Haiqing, the chief economist with Jiuzhou Securities, a mainland brokerage, wrote in a note.

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The central bank is sending a message to banks and investors alike that it won’t unconditionally pump money, Deng said.

Unlike the Federal Reserve, the ECB or BOJ, China’s central bank is not an independent agency from the government but part of China’s State Council, the cabinet. The PBOC has to follow trends from above. When China’s top leadership was placing priority on reviving growth, the PBOC cut down payment requirements to beef up bank credit for home purchases. However, that decision was revoked in major cities seven months later because of an overheated property sector.

While the PBOC is trying to increase short-term money market rates to help the weakening yuan, the central bank can’t go too far in tightening for “fears of hurting the economy,” said Wang Youxin, a researcher at the Bank of China.