MNI: PBOC’s New Overnight Tool To Lower Rates Over Time

The People's Bank of China's new overnight reverse repo tool will help lower overall interest rates as its influence grows, despite the central bank's cautious rollout aimed at tempering expectations of policy easing and limiting its immediate impact on money markets, economists and advisers told MNI.

The PBOC launched the overnight reverse repo facility in its open market operations this week using a fixed-rate, quantity-tender approach, injecting CNY300 billion on Monday and CNY600 billion on Tuesday.

Dong Ximiao, chief economist at Merchants Union Consumer Finance, said the PBOC's decision not to disclose the interest rate immediately reflected caution during the pilot phase of the new instrument, as policymakers wanted to assess the market's reaction while avoiding an overinterpretation of the move as a rate cut. Sources later confirmed the rate was set at 1.25%, unchanged over the two days and below the market expectation of 1.35%.

The tool would complement the existing seven-day reverse repo by providing a shorter maturity, allowing the central bank to manage liquidity more precisely, Dong added. (See MNI INTERVIEW2: PBOC Short-Term Rates Focus To Cap Volatility)

Sources also said the Bank withheld the rate to avoid fuelling expectations of policy easing that could have pushed the DR001 rate lower. Weak credit demand left the interbank market awash with liquidity in April and May, driving the DR001 rate down to 1.20%, well below the 1.4% policy rate, prompting the PBOC to drain liquidity to push DR001 back higher. Since June, DR001 has gradually recovered to around 1.4%. On Monday, however, the weighted average DR001 rate fell 5.4 basis points from the previous trading day to 1.30%.

The PBOC intends the new facility to serve as a neutral tool in its initial phase to smooth liquidity at critical times, meaning its immediate impact on funding rates remains limited, sources told MNI. The central bank did not conduct overnight operations on Wednesday.

LOWER RATES

Lian Ping, director of the China Chief Economist Forum, said because the overnight repurchase rate is below the seven-day reverse repo rate, its growing role as the policy benchmark in future would gradually pull down overall interest rates, particularly given the limited scope for conventional policy rate cuts.

Dong noted the facility is designed to better meet cross-quarter liquidity demand at the end of the first half, when banks face funding pressures due to end-June regulatory assessments, while also allowing the central bank to respond more flexibly to intraday liquidity needs. 

He argued the move represents an important step toward making the overnight reverse repo a regular policy instrument since the PBOC began building its interest rate corridor in 2024, improving management of short-term interest rates. (See MNI: PBOC Targets Monetary Policy Reform Via Overnight Rate)

LIQUIDITY STANCE

The new tool has done little to ease market concerns that the central bank will continue draining liquidity. Despite the PBOC's overnight injections this week, seven-day reverse repo operations recorded a net withdrawal, resulting in a rare net drain of CNY174 billion at quarter-end.

The overnight reverse repo effectively replaced part of the maturing seven-day reverse repo operations with shorter-term funding, helping prevent excess liquidity from idling in the interbank market and mitigating the surplus liquidity created by weak credit demand, sources said.

Lian explained that as bank lending becomes less dominant and bond, equity and money market financing play a larger role, money market rates will fluctuate more frequently, increasing the need for the overnight rate to become a policy benchmark. While replacing the seven-day reverse repo with the overnight rate as the key policy rate is the long-term direction, further progress is needed in interest rate liberalisation, policy transmission and liquidity circulation, he said.

To some extent, the Federal Reserve's decision to keep interest rates unchanged, or even raise them further, has constrained the PBOC's room to cut rates. Moreover, with borrowing costs already low and credit demand weak, an additional 10bp cut would likely do little to stimulate the economy.