In the intricate world of monetary policy, the People's Bank of China (PBOC) has taken significant steps to navigate through very tight liquidity conditions while ensuring that the economy remains stable. On February 25, 2024, the PBOC conducted a medium-term lending facility (MLF) operation amounting to 300 billion yuan, with a tenor of one year. The bidding rates were set, with the highest at 2.20% and the lowest at 1.80%, culminating in a successful bid rate of 2.00%. Following this transaction, the MLF balance stood at 40.94 trillion yuan, illustrating the proactive measures being employed in the current economic climate.
Notably, on the same day, the central bank executed a substantial reverse repurchase operation worth 318.5 billion yuan. Given that approximately 489.2 billion yuan in seven-day reverse repos was maturing, this move resulted in a net withdrawal of 170.7 billion yuan from the money market. The context of this operation is critical, as it coincides with the maturity of 500 billion yuan in MLF from a previous period, effectively reflecting a reduction of 200 billion yuan in MLF for February. However, this reduction does not necessarily indicate a contraction in liquidity provided by the PBOC. In January, the central bank preemptively injected liquidity into the market by conducting a 1.7 trillion yuan repos session, set to counter the impending expiration of MLF agreements.
Despite the tightening liquidity backdrop, there remains an underlying nurturing stance from the PBOC, which has led analysts to predict a sustained replacement of the MLF with reverse repos. With heightened external uncertainties at the start of the year and the pressures posed on the currency stability and interest rates, the central bank has signaled a careful approach, emphasizing an optimal timing in policy adjustments. The adaptive nature of the monetary policy framework is increasingly evident amidst these challenges, showcasing a pattern where the PBOC is adapting its tools to maintain financial equilibrium while fostering growth.
As expressed by Wen Bin, Chief Economist at China Minsheng Bank, the current focus of monetary policy is to stabilize the yuan, mitigate risks associated with interest rates, and prevent any shifts in the economic balance. Banks are primarily engaged in liquidity absorption in open market transactions, driving bond market rates to return to a reasonable level. Signs of a stabilizing economic baseline indicate a reduced necessity and likelihood for short-term easing of monetary policy, where the persistence of a steady policy interest rate has been evident. The continuation of the smaller-scale MLF operations aligns with market expectations.
Since March of the previous year, the PBOC has continually reduced its MLF operations, with current balances declining to over 40 trillion yuan. Moving forward in this evolving monetary policy landscape, the PBOC is progressively minimizing the role of MLF in its toolkit. Dong Ximiao, a chief researcher at the Financial Research Institute, reiterated that the ongoing reduction reflects a decreasing demand from financial institutions for MLF, especially considering the current rate of 2.00%, perceived as relatively high in today's environment. Institutions are increasingly reliant on the opportunity presented by reverse repos as an alternative.
For instance, in January, the central bank conducted a large-scale reverse repo operation totalling 1.7 trillion yuan, targeting various maturities, including three-month and six-month terms, thereby enhancing its ability to regulate short to medium-term liquidity efficiently. The inherent strategy since October 2023 has featured consistent undertakings of high-value reverse repos aimed at gradually replacing the MLF, thereby diminishing its value as a policy rate benchmark.
Wang Qing, Chief Macro Analyst at Dongfang Jin Cheng, noted a crucial observation – even in the face of a temporary halt in secondary market government bond purchases by the central bank, significant fluidity is maintained through expansive reverse repos and moderate MLF operations. This strategy fortifies the medium-term liquidity within the market considerably, supporting banks in heightening their lending, particularly related to government bond issuances and stabilizing market expectations moving forward.
Despite persisting tight money conditions, the central bank assiduously maintains a balanced approach to liquidity. Since the beginning of the year, the PBOC has upheld a firm stance on its policy framework, tightening liquidity overall. Following the pace of government bond issuances, increased credit demands, and seasonal tax activities, the money market has seen notable volatility, with funding rates climbing rapidly. As per the latest report on February 25th, the money market remained tense, with varied performances across shorter-term rates.
At the time of writing, the weighted average rate for DR007 had increased by 16.11 basis points, reaching 2.2161%, consistently surpassing the policy rate of 1.5%. Conversely, the DR001 average rate registered a decrease of 0.88 basis points to 1.8686%, while the overnight SHIBOR marked a slight drop by 0.40 basis points to 1.862%. These variances showcase how market conditions have exerted pressure on banks' liabilities, exacerbating their funding costs.
Insights from Chen Jianheng, Head of Fixed Income Research at CICC, suggest that the fluctuating US dollar and high yields in US treasury securities contribute to the pressure on the renminbi, necessitating the central bank's focus on maintaining a stable exchange rate. Rapid government bond issuances and seasonal factors such as reserve requirements and tax payments have further constrained funding availability within the banking system, exacerbating short-term market fluctuations.
Looking ahead, a considerable amount of interbank certificates of deposit are set to mature, alongside a significant volume of reverse repos scheduled for March and April, with a total of around 3 trillion yuan due. Wen Bin cautions that unless the pace of government bond issuances and credit expansion diminishes markedly, the ongoing pressures on liquidity are unlikely to alleviate easily. Nevertheless, under the overarching theme of tight balance, the central bank's nurturing attitude prevails. Compared to previous months, the notable reduction in February's MLF (a decrease of 200 billion yuan) is notably less drastic than reductions witnessed in late 2023.
This indicates to market analysts that an increasing demand from financial institutions for MLF is emerging in response to rapidly rising market rates, suggesting a critical dynamic in the evolving financial environment.
In light of these developments, the PBOC's focus on replenishing its toolkit has become more pronounced, with anticipation of continued MLF reductions as it redirects strategy toward utilizing reverse repos and government bond purchases. Dong Ximiao predicts ongoing reductions in MLF operations, emphasizing the potential for further declines in capital costs for financial institutions. Moreover, Wen Bin wishes to underline that the need for adjustments, particularly concerning reserve requirement ratios, will remain a factor in maintaining liquidity after achieving stability in the renminbi's exchange rate.
This dynamic may well position the central bank to facilitate a conducive financing environment that encourages steady growth while effectively managing its monetary policy responsibilities.