China’s Short-Term Money Rates Surge as Markets Anticipate Further Policy Easing

SHANGHAI (Reuters) – On the last trading day of the month, China’s short-term money rates surged due to increased seasonal cash demand, even as market expectations suggest that the central bank may inject more liquidity in the coming months to bolster a weak economic recovery.

The benchmark overnight repo rate in the interbank market soared by as much as 255 basis points to 4% during morning sessions, marking its highest level since February 28. It was last recorded at 1.8658% on Tuesday afternoon.

The rise in borrowing costs coincides with month-end cash demands, as financial institutions are obliged to maintain elevated cash levels to meet various regulatory requirements. This situation has made banks hesitant to lend to one another.

"I was caught off guard by the liquidity tightness; the prices shot up unexpectedly," commented a trader at a brokerage.

The People’s Bank of China (PBOC) injected a net 19 billion yuan through open market operations on Tuesday. However, some bond traders noted that this injection was insufficient, as many banks have grown more conservative in their lending practices as they approach month-end.

In the derivatives market, investors remain optimistic that liquidity pressures will not last long. They are expecting increased liquidity injections and potential interest rate cuts in response to the government’s recent approval of 1 trillion yuan in sovereign bond sales.

Interest rate swaps for one-year terms, which reflect investor expectations for future yields, decreased by 7 basis points this week to 2.02% following the announcement of the new debt issuance aimed at aiding the recovery of disaster-affected areas.

"Repo-IRS trading showed some softness this morning, influenced by China’s PMIs being lower than anticipated, while the market continues to anticipate further liquidity injections to mitigate the effects of increased bond supply," said Frances Cheung, a rates strategist at OCBC Bank.

"There is now a greater likelihood of a reserve requirement ratio (RRR) cut, which would be beneficial, as a 25-basis-point reduction could provide significant liquidity to accommodate the additional bond issuances."

Sources have indicated that China’s issuance of these sovereign bonds will not affect the schedule for the central government’s bond issuance in the fourth quarter.

As the Chinese government accelerates spending plans to support an economic recovery that has faltered this year, investors are betting that the central bank will further ease monetary policy.

Ming Ming, chief economist at Citic Securities, anticipates that repo rates will decline in November as the central bank is likely to maintain a bias toward loosening its monetary policy.

"Possibilities remain for an RRR cut or additional liquidity through medium-term lending facility (MLF) rollovers this year," Ming stated.