MNI: PBOC Targets Monetary Policy Reform Via Overnight Rate

China's efforts to strengthen control of overnight interest rates will reduce volatility in interbank funding markets and support a transition toward an overnight-rate-based monetary policy framework like that used by other major central banks, economists told MNI, noting the changes should ultimately lower financing costs in the real economy.

The 20-basis-point narrowing of the short-term interest-rate corridor to 50bp – announced by People's Bank of China Governor Pan Gongsheng Wednesday – will limit fluctuations in overnight rate, reduce funding-rate volatility and stabilise liquidity expectations among financial institutions, said Dong Ximiao, chief economist at Merchants Union Consumer Finance, complementing Pan's plan to narrow the interest-rate corridor by setting the upper and lower bounds of the temporary overnight repo and reverse repo facilities at 25bp above and below the 7-day reverse repo rate.

A more effective framework for managing short-term rates would strengthen the transmission mechanism from policy rates to market rates and ultimately to lending rates,  helping reduce financing costs for businesses and households, Dong argued when talking about the planned overnight repurchase facility. (See MNI: PBOC To Reduce OMOs Further, Drain Bond Liquidity)

The latest measures represent another step in the PBOC's shift from managing the quantity of liquidity toward influencing the cost of funds through interest rates, building on a reform blueprint first outlined in June 2024.

Wang Qing, chief macro analyst at Orient Golden Credit Rating International, told MNI that the combination of a benchmark overnight reverse repo facility and a narrower corridor would improve the stability of the DR001 money market overnight rate, strengthening policy transmission along the yield curve and enhancing the effectiveness of price-based monetary policy.

The current short-term rate corridor is centred on the 1.4% 7-day reverse repo rate, with temporary overnight repo and reverse repo rates serving as the lower and upper bounds. Following Pan's announcement, the corridor now ranges from 1.15% to 1.65%, compared with the previous 1.20% to 1.90%.

OVERNIGHT RATE

Ming Ming, chief economist at CITIC Securities, said the planned overnight repurchase tool would likely operate regularly in a manner similar to the existing 7-day reverse repo.

While the rate has not yet been announced, Wang estimated it could be set at 1.3%, or 10bp below the current 1.4% 7-day reverse repo rate. If the overnight rate is eventually designated as the benchmark policy rate, it could replace the 7-day reverse repo rate as the basis for the Loan Prime Rate, he added.

Dong, however, cautioned that the 7-day reverse repo rate will remain the primary policy rate in the near term, as the current corridor continues to be centred on that rate, reinforcing its role as the key policy anchor.

The PBOC stressed that it will conduct operations when primary dealers require funding and when DR001 moves outside the corridor boundaries, underlining its intention to manage short-term rates more actively.

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 the Federal Reserve, the European Central Bank and the Bank of Japan, centred on a single overnight policy rate and an interest-rate corridor. (See: MNI INTERVIEW: China Property Bailout Would Take 10% Of GDP)

Lu agreed the benchmark policy rate is likely to migrate from the 7-day reverse repo rate toward an overnight rate. He argued that active trading of short-term government securities would provide the PBOC with a vehicle for high-frequency operations and more precise management of overnight funding conditions, allowing policymakers to focus more on interest-rate signals and less on direct liquidity management.