PBOC will remain active in China rates market, but volatility will persist
As financial reform in China continues, the People’s Bank of China (PBOC) faces the challenging task of a smooth transition in interbank and FX markets. On the surface historical interest rate volatility suggested a firm stance which left the market to its own devices. If we look at PBOC response to liquidity tightness however, we see consistency in policy fine-tuning. In 2011 PBOC reduced a net RMB 600 bn in repo positioning very gradually, easing the tight July liquidity season in the process but failing to prevent spikes with rates reaching 8%. In markets with a proactive central bank (like the Fed,) open-market operations (OMOs) which result in looser liquidity should see rates fall; in China liquidity loosening accompanies rising rates as the central bank tries to ameliorate exogenous drivers of tighter liquidity. Last July PBOC’s OMO response was initially tepid to seasonal liquidity demand. Not until repo traded above 8% levels did PBOC decide to act through small, short-tenor injections.
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