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China’s central bank has introduced a new cash management tool this week, featuring temporary bond repurchase (repo) agreements and reverse repos. This addition to its range of open market operations is poised to become an important interest rate indicator. Here’s a closer look at the mechanics and intent behind this new tool, which market participants believe is a significant step in the People’s Bank of China’s (PBOC) evolving monetary policy framework.
WHAT ARE TEMPORARY REPOS AND REVERSE REPOS?
Repos and reverse repos are short-term cash management instruments that allow primary dealers to exchange government bonds for cash with the central bank, either to borrow or park funds. Under temporary overnight repos, the PBOC can sell securities to primary dealers with an agreement to repurchase them the following day, effectively draining cash from the financial system. Conversely, reverse repos enable the PBOC to inject funds.
DETAILS OF THE PBOC’S TEMPORARY REPO OPERATIONS
The PBOC announced that temporary overnight repo and reverse repo operations will occur in the afternoon, between 4 p.m. (0800 GMT) and 4:20 p.m. on working days, if deemed necessary based on market conditions. This contrasts with its other routine daily operations, which are conducted in the morning. The interest rate on temporary repos and reverse repos will be 20 basis points below and 50 basis points above the seven-day reverse repo rate, or 1.6% and 2.3%, respectively.
REASONS BEHIND THE PBOC’S NEW REPOS
Analysts believe this mechanism allows the seven-day reverse repo rate to evolve into a new policy benchmark. PBOC Governor Pan Gongsheng recently indicated that this rate “basically fulfills the function” of the main policy rate but suggested a narrower interest rate corridor might be needed. The interest rates on the temporary repos and reverse repos will form a new interest rate corridor with a width of 70 basis points. Currently, the market operates within a wide 245 basis points range between the seven-day standing lending facility (SLF) rate and the central bank’s interest rate on excess reserves (IOER).
WHY NOW?
The central bank has been issuing warnings and introducing measures, including plans to sell treasury bonds, to cool a prolonged bond rally. PBOC’s Pan emphasized the need for prompt action to mitigate risk accumulation in financial markets and maintain a normal upward-sloping yield curve. Ju Wang, head of Greater China FX & rates strategy at BNP Paribas, noted that a steeper yield curve could support the weak yuan by attracting overseas investors to yuan bonds. The yuan has depreciated 2.4% against the strengthening U.S. dollar this year, due to its relatively low yields compared to other economies.
IMPACT ON INTEREST RATES OF OTHER MONETARY POLICY INSTRUMENTS
Pan mentioned that the PBOC might consider a single short-term interest rate as the key policy rate. If the seven-day reverse repo rate fulfills this role, it could smooth policy transmission to other benchmarks and tenors.
This new tool by the PBOC signifies an important shift in China’s monetary policy approach, aiming to enhance market stability and policy effectiveness amid evolving economic conditions.
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