MNI PBOC WATCH: New Overnight OMO Tool To Reduce Funding Costs

Although China's Loan Prime Rate remained unchanged this month, the People's Bank of China's planned overnight-rate reforms could effectively deliver a modest monetary easing by lowering funding costs across the financial system.

China's Loan Prime Rate remained unchanged on Monday at 3.0% for the one-year maturity and 3.5% for the five-year tenor and over, marking a 13th consecutive month without change. Both rates were last reduced by 10 basis points in May 2025 after the PBOC lowered its benchmark seven-day reverse repo rate by 10bp to 1.4% on May 8, followed by a 50bp cut to the reserve requirement ratio on May 15. (See MNI PBOC WATCH: June LPR To Hold Despite Economic Slowdown)

INTEREST-RATE REFORM

Governor Pan Gongsheng announced last Wednesday that the central bank would introduce an overnight reverse repo facility while narrowing the interest-rate corridor by 20bp. The Bank will set the upper and lower bounds of the temporary overnight repo and reverse repo facilities at 25bp above and below the seven-day reverse repo rate to promote the transition of the monetary policy framework toward a price-based regime, improving the precision and effectiveness of short-end interest-rate management.

Dong Ximiao, chief economist at Merchants Union Consumer Finance, told MNI the changes would limit fluctuations in overnight rates, reduce funding-rate volatility and stabilise liquidity expectations among financial institutions, helping lower financing costs for businesses and households. (See MNI: PBOC Targets Monetary Policy Reform Via Overnight Rate)

The current short-term interest-rate corridor is centred on the 1.4% seven-day reverse repo rate, with temporary overnight repo and reverse repo rates serving as the lower and upper bounds. The corridor now ranges from 1.15% to 1.65%, compared with the previous 1.20% to 1.90%, following Pan's announcement.

Analysts interpreted the announcement as a signal that the PBOC intends to keep DR001 fluctuating closely around the seven-day reverse repo rate, while also highlighting the possibility that the overnight rate could eventually become the benchmark for loan pricing.

While the rate on the planned overnight reverse repo facility has yet to be announced, Wang Qing, chief macro analyst at Orient Golden Credit Rating International, estimated authorities could set it at 1.3%, 10bp below the current seven-day reverse repo rate. If the overnight rate is eventually designated as the benchmark policy rate, it could replace the seven-day reverse repo rate as the LPR’s benchmark, he added.

LOWER FUNDING COSTS

Analysts noted that if the overnight reverse repo rate is set at 1.3%, policy rates from the seven-day reverse repo to the one-year Medium-Term Lending Facility could gradually converge toward the new benchmark. That would lower banks' funding costs by between 5-10bp, generating an easing effect similar to a policy-rate cut even if the benchmark rate itself remains unchanged.

According to Lu Ting, chief China economist at Nomura, the direction of the PBOC's interest-rate framework reform is clear, with China gradually moving toward the simplified structures used by other major central banks. He agreed that the benchmark policy rate is likely to shift from the seven-day reverse repo rate toward an overnight rate. 

MNI INTERVIEW: ECB Ready To Hike Or Change Course - Kocher

The European Central Bank is close to its baseline inflation scenario following the end of hostilities in the Gulf but remains prepared to hike rates or to change its monetary policy stance if necessary, Austrian National Bank governor Martin Kocher told MNI.

"Clearly we want to avoid unnecessary hikes given the economic situation, but if the data indicate that additional action is needed to ensure inflation returns sustainably to target, we are fully prepared to take it," Kocher said in an interview.

“As for where we stand now, it is still too early to say. We have had a week with lower energy prices and there is some optimism, which I hope will continue. At this stage, we are still very close to our baseline. Whether that remains the case will depend on how events unfold over the coming weeks. We still have around five weeks until the next meeting, which is a long time in the current environment.”

Kocher said last week’s 25-basis-point rate hike was necessary “in all the scenarios, even in the mild scenario,” and that there was “clearly a signal that it's not an insurance hike given the projections for the inflation outlook.”

Asked whether September’s meeting, which will be accompanied by fresh ECB staff macroeconomic projections, would be the next live decision, Kocher said that while policymakers would hike if necessary, it cannot be assumed that every meeting will mean a rise in interest rates. (See MNI ECB WATCH: ECB Hikes, Sticks With Meeting-By-Meeting)

“If it turns out to be the case that everything unfolds much more positively and much more quickly than expected, then given our general approach there is no reason not to change the monetary policy stance," he said. “But it is far too early to draw conclusions about future policy decisions.”

A potential increase in the neutral rate of interest to 2.5%, cited again by ECB chief economist Philip Lane this week, has been circulating for some time in academic circles, and discussed by the Governing Council, according to Kocher. Though the precise figure is hard to calculate, it “does not seem implausible, which would mean our current policy stance would be around neutral or perhaps is still slightly expansionary,” he said.

NO SECOND-ROUND SIGNS

So far there is no widespread evidence of second-round effects, Kocher said, though indirect effects of the price shock following the closure of the Strait of Hormuz are visible, and there are "clearly" some indications of inflation propagation.

“Although widespread evidence of second round effects is not present, it's not surprising. Usually, second round effects in supply shocks are associated with wage negotiations, and while some have taken place since the beginning of the war, it’s not that many in Europe. So we have to remain cautious here,” he said.

The euro area economy started 2026 “quite strongly,” with some underlying momentum carried forward despite the war, raising hopes of further improvements over the medium term, he said.

“That makes it unlikely that our growth outlook for 2026 is overly optimistic. It could even turn out somewhat better if the situation continues to improve in the Middle East.

“As for 2027 and 2028, uncertainty is still high. That said, I remain cautiously optimistic. A lot of investment has been postponed and savings rates are high, so there is considerable potential for higher growth rates once uncertainty begins to recede.”

TRADE RISKS

Trade has been a frequent topic of discussion within the Governing Council, Kocher said, including the impact of Chinese overcapacity, and potential European responses such as the Industrial Accelerator Act, on price pressures. 

“Permanently rerouting trade is likely to have price effects over the longer-term. At the same time the EU is seeking greater strategic sovereignty in some areas - which is perfectly legitimate. However, whenever that happens, we will have to discuss the impact on prices, since there are clearly capacity constraints,” he said.

“It remains to be seen to what extent the European Union will implement these kinds of proposals. But it should also be remembered that trade agreements, such as those with Australia and India, can lead to lower prices for certain products and services, at the same time.”

MNI INTERVIEW: Fed Warsh 'Strategically Hawkish' - Lockhart

Kevin Warsh navigated a delicate balancing act between reformer and institutionalist in his first FOMC meeting, heralding a rethink of key policy tools while carrying forward a hawkish shift that had already begun under his predecessor, former Atlanta Fed President Dennis Lockhart told MNI. 

A hike is firmly on the table this year, Lockhart added, citing the committee's updated policy statement and rate projections, which signaled the Fed's first serious consideration of rate increases since the current inflationary cycle began. 

"There's a better-than-even chance of a hike this year, but that presumes that the inflation picture continues to be troubling and that the committee feels it has to act," he said. (See MNI INTERVIEW: Fed’s Next Rate Move Most Likely Upward-Kohn)

STRATEGICALLY HAWKISH

The FOMC's updated Summary of Economic Projections revealed a committee shifting decisively toward tightening, upgrading inflation projections while downgrading its growth forecasts. Nine out of 18 rate projections showed one or more increases in the second half of the year, compared with nine for maintaining or lowering rates.

Even as Warsh tried to say as little as possible on the future path of interest rates, his tone was "strategically hawkish" -- careful but pointed, driven not so much by what he said as what he left unsaid, Lockhart said.  

"The current conditions call for hawkishness. He never stated that explicitly, but you can infer that," he said. 

"He made the statement that the committee is committed to restoring price stability. The committee has missed its target for over five years. It would be inconsistent with that longer-term statement to say we prioritize employment under the current situation."

LESS IS MORE

The revised policy statement, stripped of what Lockhart called "a lot of boilerplate," was a signal of how Warsh intends to run the institution, Lockhart said. 

"This was a simplification and a very direct statement without the forward guidance in it. Clearly one of Kevin Warsh's views is less is more when it comes to Fed communications."

The committee's reaffirmation that it would maintain ample reserves in the banking system signaled no aggressive effort to unwind the balance sheet in the near term, while the closing declaration -- "The Committee will deliver price stability." -- makes clear that the inflation objective takes priority, Lockhart said. 

"I don't think it somehow dismisses the other side of the mandate, the employment side." 

VOLUNTARY DOTS

That Warsh declined to submit his own dot was a break with convention that raises questions about whether participation in the projection process is becoming voluntary. Warsh has set up a communications task force, and changes to the SEP could follow by year-end, Lockhart said. (See MNI INTERVIEW: Warsh Could Overhaul SEP, Drop Dot Plot - Lewis)

"If people opted out and this gets to be a little bit more of a ragged process -- note that one person chose not to put in a forecast for 2028 -- then it will tell you less about the thinking of the committee overall," he said. "The dots give you a sense of the mind of the collective participants of the committee at that particular time. That's not exactly what the market wants -- the market wants certainty and definitive statements -- but it's something." 

Replacements for the dot plot have been debated in the past, including a single committee forecast, but never implemented due to the difficulty of reaching consensus.

"It would be far too hard. We would be cloistered for a week or more trying to get to a consensus forecast. Because of the degree of difficulty of that perhaps more useful communications device, the committee always fell back on: let's stick with the dots, they're as good as we can deliver."

MNI INTERVIEW: Even UK Young Pessimistic On Consumption - GfK

UK consumer confidence was unchanged in June but there was a noticeable downturn in the outlook of the previously-optimistic younger demographic, the head of a leading survey told MNI.

"Consumer confidence was unchanged in June but the lack of movement in the headline figure is misleading as, beneath the surface, there are new signs that confidence is weakening," Neil Bellamy, consumer insights director at GfK, an NIQ company, said.

Overall, "confidence remains subdued and vulnerable to further economic or political uncertainty," he said.

"The biggest fall this month is among those aged 16 to 29, traditionally one of the most optimistic groups," Bellamy noted, pointing to confidence dropping 11 points in that age group over the last two months to the lowest in two years, driven "by large falls in views on both their own personal finances and the wider economy."

NO POSITIVE SCORES

There are now "no demographic groups with a positive confidence score, including higher-income households earning GBP50,000 or more," who have slipped back into negative territory as of June, Bellamy said.

The Overall GfK Confidence Barometer was unchanged at -23 in June. One internal measure was higher, two down and two the same, when compared to last month.

"Views on personal finances going forward are flat at -2, and the backwards-looking measures of personal finances and the economy are both slightly down, reflecting the sense that things have been extremely tough over the last year for so many. The only value to increase is for the wider economy in the next 12 months, up two points from -38 to -36," Bellamy said.

MNI INTERVIEW: Former RBA Research Chief Warns Of Higher Rates

Poor communication by the Reserve Bank of Australia has led markets to underprice the risk of further tightening, with another 25-basis-point increase to the 4.35% cash rate highly likely in August, the RBA's former head of research told MNI.

John Simon, who led the Bank's economic research department from 2014 to 2024, said the RBA risks damaging its credibility if investors begin doubting its willingness to raise rates further to return inflation to target. Inflation expectations are already increasing in ways that matter for future inflation outcomes, particularly through wage- and price-setting behaviour, he said in an interview.

“If expectations continue to drift higher alongside worse inflation reads, then yes that would be a credibility issue,” Simon said.

Markets currently assign only a 32% probability to an August rate increase, with around 15bp of additional tightening priced by December, following the board's decision to hold the cash rate steady on Tuesday. (See MNI RBA WATCH: Bullock Keeps Hike Prospects Alive Despite Hold)

"I would also have voted for a pause at this meeting, but they are much more likely to go for a raise next meeting,” Simon said, though he acknowledged that the RBA may ultimately choose to wait. "They have to keep hikes on the table.”

He pointed to recent wage decisions by the Fair Work Commission and unions that incorporate compensation for past inflation, arguing these developments risk embedding inflationary pressures in the economy. "You can't wait until the 10-year expectations let go. That's when it's too late," he said.

BANK COMMUNICATIONS

Simon also called on the RBA to explain its strategy and provide greater insight into how it intends to balance inflation risks, uncertainty and the timing of policy moves. "The market's swinging all over the place because all they can really take a read on is what's the vibe today, and then they just project that out into the future," Simon said.

Rather than attempting to communicate policy through individual decisions and post-meeting statements, the RBA should explain whether it intends to front-load inflation fighting or proceed more gradually, Simon said. Such guidance would not constitute a forecast or commitment but would help markets better understand how policymakers are managing risks.

The Bank's historical tendency to underestimate inflation pressures continues to shape investor expectations, he added. "I think people have still got this lingering feeling that the Bank is weighing unemployment more heavily than it has in the past, trying to follow the 'narrow path' and keep interest rates as low as possible," Simon said. The RBA's current approach of taking policy one meeting at a time amounts to tactics rather than strategy, leaving a vacuum that markets fill with speculation, he concluded. 

TO HIKE OR HOLD

While the RBA recently acknowledged some movement in shorter-term inflation expectations, Simon — who has previously criticised the Bank's dovishness — argued policymakers face a choice between tightening further now and holding rates for a shorter period or maintaining the current cash rate for longer. So far, they have responded later than they should have, he said, arguing that a sustained period of restrictive monetary policy is necessary. (See MNI INTERVIEW: More Hikes As RBA Softens Labour Stance)

"There would be a strong case to be made for going a little bit harder earlier," he said, citing inflationary pressures from wage growth and the lingering effects of recent supply shocks. 

Recent signs of softer economic activity should not be interpreted as evidence of a sustained slowdown, he said. Instead, households and businesses appear to be temporarily pausing spending and investment decisions amid heightened uncertainty, reflecting caution rather than a lasting deterioration in demand, making it difficult to identify a convincing source of sustained disinflation.

MNI INTERVIEW: Fed’s Next Rate Move Most Likely Upward-Kohn 

The Federal Reserve’s next move on interest rates is likely to be higher as long inflation pressures linger and given new Fed Chair Kevin Warsh’s strong focus on the price stability side of the central bank’s mandate, former Fed vice chair Donald Kohn told MNI. 

“To carry through on the emphasis and priority given to price stability, is the next move more likely to be up or down? I would say it's more likely to be up,” said Kohn, a four-decade veteran of the Fed who is now at the Brookings Institution.

While Warsh was circumspect in offering policy guidance or even detailed insights into his economic views, Kohn said there was a hint of it when the chair spoke about the degree of policy restrictiveness, describing it as uneven. 

That, Kohn noted, was a break from Jerome Powell’s R-star focused approach, which would lead the former chair to say policy was mildly restrictive.

Warsh also repeatedly emphasized his commitment to returning inflation to 2% after more than five years of overshoot, painting it as the FOMC’s primary immediate goal. His hawkishness took many investors by surprise.   

“I share some of the skepticism on whether they are headed back to 2%. And I was a bit skeptical on whether they needed, particularly, that last cut in December, the insurance cut,” he said. 

“Growth is solid, the labor market looks solid. If wealth continues to build and there isn’t some evidence of the surge in productivity, the argument might be they bought a little too much insurance last year and they have to take it back.” (See MNI INTERVIEW: Fed At Neutral Risks Entrenched 3% Inflation-Koenig)

Kohn said he expected a hawkish shift in the tone and substance of the Fed’s internal deliberations but was surprised by how quickly the transition to active discussion of rate hikes had taken place. 

“The direction of travel was where I expected things to go but the travel was further than I thought it would go,” he said. 

TASK FORCES

The former vice chair welcomed Warsh’s launch of various task forces to examine possible improvements in everything from communications to the balance sheet. He said there is precedent for this around the world. 

“I think that's a great idea. It gives time, six months at least, for him to get his feet on the ground and figure out what needs to happen, what's already happening, etcetera. I like the idea of bringing in some outside voices into those task forces. It's a little tricky with confidential information and whatnot, but that can be handled,” said Kohn.

“There are other central banks – the Bank of England, the Riksbank, Reserve Bank of New Zealand, the Reserve Bank of Australia – that have brought in outsiders to evaluate them. And in this case he's talking about task forces that are joint insiders and outsiders, so I think that's a very constructive way to proceed.”

ECONOMIC NARRATIVE

Warsh’s reluctance to offer economic clues led to a dearth of information about his inclinations that will need to be addressed more directly as his tenure evolves, said Kohn 

“He kind of used the dialing back for guidance to avoid saying very much about how he was viewing, or the committee was viewing, the economy. Why was the inflation forecast revised so much? Why were the dots revised so much higher? We didn’t get that. How is inflation going to come down over time. We didn’t get that either. 

“But he's only been there three weeks, so I think it was a good start. Even if he doesn't give forward guidance on interest rates, he needs to give a story, a narrative around what's happening in the economy, why it's happening, what the committee led under his leadership will be looking at.”

MNI BOE WATCH: Future Hike More Remote Prospect After 7-2 Hold

The Bank of England voted seven-two to hold Bank Rate at 3.75% on Thursday, while stressing uncertainty over the outlook for energy prices, any second-round effects and output even with an Iran peace deal.

The voting pattern was very similar to that of April’s meeting, with only Megan Greene's vote changing as she joined Chief Economist Huw Pill in voting for a 25-basis-point hike. The majority were sceptical that material second-round effects were likely.

"The labour market continues to loosen, and signs of a weakening economy could contain inflationary pressures," the Monetary Policy Committee said in its statement, which also noted that an increase in "interest rates faced by households and businesses ... will act to reduce inflation over time."

Even after the news of a ceasefire in the Middle East, global energy prices "remain higher than pre-conflict and have continued to be volatile," the statement said.

INFLATIONARY PRESSURE

Governor Andrew Bailey said that "whatever happens in the future, the higher energy prices of the past four months mean there's already some inflationary pressure in the pipeline."

Still, after a fall in headline May CPI inflation to 2.8%, Bailey wrote in his personal paragraph that "recent inflation outturns give greater confidence that gradual underlying disinflation has continued." (See MNI INTERVIEW:UK Inflation Peaks Year End, Stays High-Sentance)

He also raised the risk posed by excessively restrictive policy.

"Our remit recognises that attempting to bring inflation back to the target too quickly may cause undesirable volatility in output ... tolerating temporarily above-target inflation as part of a return to target is an appropriate way to approach the trade-off, providing inflation expectations remain contained," he said.

According to the minutes of the June meeting, the June Market Participants Survey found median expectations were for a June hold and "thereafter, for Bank Rate to remain unchanged for the year ahead," even as market pricing continues to imply a full hike by year-end. 

Households' near-term inflation expectations had "picked up materially" in the Bank's polling with Ipsos, rising from 3.2% in February to 4.0% in May. (See MNI INTERVIEW: UK Inflation Expectations More Loosely Anchored)

SECOND-ROUND RISKS

But Deputy Governor Sarah Breeden said that "the economic environment means the chance of material second-round effects is small," though she remains "committed to acting early and decisively should material second‑round effects become likely."

Clare Lombardelli, another of the BOE's Deputy Governors, said she would react to "signals to indicate inflation would persist above target," but that tighter financial conditions continue "to weigh against the greater inflation pressures," while Swati Dhingra also did not see compelling reasons to move "pre-emptively."

Alan Taylor, who has generally voted for a lower path for Bank Rate than the committee at large, said "the yield curve shows we have tightened a lot just by holding," while "absent mechanical direct and indirect energy effects from the conflict, CPI inflation would have been at target in April.” Deputy Governor for Markets Dave Ramsden said his "reaction function will remain state-contingent on both the development of the conflict, and what that means for the outlook for the economy."

Catherine Mann believed risks tilted to the upside on inflation, but that the committee could react quickly to this materialising, as "research shows that a forceful Bank Rate decision can have a quick effect on inflation and inflation expectations."

On the contrary, Megan Greene said that a "proactive hike now in Bank Rate should help anchor inflation expectations," after referencing a personalised scenario from a recent speech that she used to claim that delaying a hike would risk embedding persistent inflation. Chief Economist Huw Pill, who has consistently voted for higher rates than the committee, voted for "prompt but modest action" to "put the MPC in a good place from which to respond to the evolution of events from here."