Credit control: China drains $8b from banking system

China’s central bank sold repurchase contracts for the first time since June, draining funds from the banking system as money-market rates sink to the lowest levels in at least three months.

The People’s Bank of China conducted 48 billion yuan ($7.9 billion) of 14-day repurchase contracts at 3.8 per cent on Tuesday, according to a statement posted on its website. The monetary authority last issued such contracts on June 6, when it sold 10 billion yuan of 28-day repos. The rate is higher than both the 2.75 per cent in the June auction and the 2.05 per cent when the PBOC last issued 14-day repos in January 2011.

The seven-day repurchase rate, a gauge of funding availability in the banking system, fell eight basis points to 3.76 per cent as of 5:02 pm in Shanghai, according to a weighted average by the National Interbank Funding Center. It touched 3.71 per cent, the lowest since November 13. The overnight rate dropped as much as 24 basis points to 2.63 per cent, the lowest since May.

“The central bank needs to maintain funding costs at an appropriate level, and a seven-day repo below four per cent isn’t normal,” said Huang Wentao, a Beijing-based bond analyst at China Securities Co. “The PBOC will probably continue repo operations and monetary policy will continue to be neutral-to- tight in the first two quarters.”

China’s 10-year bonds declined, with the yield on the 4.08 per cent government bonds due August 2023 climbing four basis points, or 0.04 percentage point, to 4.56 per cent, data from the National Interbank Funding Center showed. That’s the biggest gain since January 23. The yield dropped to 4.49 per cent on February 13, the lowest since December 4.

Rate corridor

One-year interest-rate swaps based on the floating seven- day repo rate were unchanged at 4.84 per cent, after climbing as much as four basis points, based on data compiled by Bloomberg. “Today’s move showed the PBOC may be referring to an interest rate corridor in implementing its ‘prudent’ policy’,” said Wang Ming, marketing director at Shanghai Yaozhi Asset Management LLP, which oversees two billion yuan of fixed-income investments. “It hopes to keep market rates within a reasonable range, with the seven-day repo at about four per cent to eight per cent.”

The PBOC asked lenders to submit orders for seven-and 14-day reverse repos, 28-day repos and 91-day bills while gauging demand on Monday, without including 14-day repos, said a trader at a primary dealer required to bid at the auctions. The central bank will sell 50 billion yuan of nine-month treasury deposits on behalf of the Ministry of Finance on February 20, according to a statement posted on the website.

Volatile rates

About 43 per cent of respondents in a survey of 69 market participants expected repo operations by the PBOC, compared with 57 per cent who didn’t expect one as of Monday, according to a note by Guotai Junan Securities Co sent on Tuesday.

Volatility in money-market rates will persist and borrowing costs will rise, the PBOC signaled in its fourth-quarter monetary policy report released February 8. “When the valve of liquidity starts to tame and curb excessive credit expansion, money-market rates, or the cost of liquidity, will reflect that,” it said.

The draining of funds by the PBOC comes as the Federal Reserve continues to cut its monthly stimulus, with Chair Janet Yellen saying on February 11 that only a “notable change” in economic prospects would prompt policy makers to slow the pace of tapering. The US central bank has reduced its purchases of Treasuries and mortgage debt to $65 billion a month, from $85 billion last year.

China’s stocks fell, with the benchmark Shanghai Composite Index slipping 0.8 per cent to 2,119.07. It closed at the highest level in two months on Monday. The Hang Seng China Enterprises Index declined 0.4 per cent.

Conducting repos is “a hawkish move highlighting the central bank’s determination to tighten monetary policy via liquidity tools,” said Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole CIB.

The move indicates that “policy makers are uncomfortable with the recent decline in money-market rates and with the explosive growth of bank lending and other forms of social financing in January,” he said.