Chinese central bank's move to cool bond rally may fall flat, analysts say

The Chinese central bank's move to use overnight policy tools to tame a rally in government bonds will have little long-term impact, as investors are still pessimistic about the country's economic recovery, according to analysts.

The People's Bank of China's (PBOC) latest efforts on Monday to defend declining bond yields pushed up 10- and 30-year Chinese government bonds by 1.5 and 1.0 basis points to 2.29 and 2.52 per cent, respectively, according to official data. However, the yields are hovering around record lows as investors continue to bet on these risk-free bonds.

The central bank will conduct temporary repos and reverse repos depending on the market conditions to "keep banking system liquidity ample" and "make market operations more efficient", the PBOC said in a statement on its website. The interest rates on the temporary repos and reverse repos will be, resepctively, 20 basis points below and 50 basis points above the seven-day reverse repo rate, which currently stands at 1.8 per cent.

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The new measure will help the central bank contain volatility in short-term rates, but "it remains uncertain whether it will help the PBOC bolster long-term Chinese government bond [CGB] yields", according to a Nomura research note on Monday.

Central banks use reverse repos to inject cash into the banking system by purchasing securities from commercial banks with an agreement to sell them back in the future, whereas a repo is used to withdraw funds from the market.

"Following the PBOC announcement, interest rates moved up modestly by two to four basis points across the curve," said Andy Suen, co-head of Asia fixed income at Pinebridge Investments. "As such, it appears that the market is concerned whether this latest measure is signalling the PBOC may withdraw liquidity in the repo market to tame the CGB rally."

The repo operations follow PBOC governor Pan Gongsheng's comments last month that the seven-day reverse repo will act as the main policy rate and is part of the bank's efforts to create a new, narrower interest rate corridor.

Pan Gongsheng, governor of the People's Bank of China. Photo: Bloomberg alt=Pan Gongsheng, governor of the People's Bank of China. Photo: Bloomberg>

Nomura economists said that the official interest rate corridor, or the range between the rates on the excess reserves and the standing lending facility, is "simply too wide to be meaningful".

Market participants and analysts suggested that while the PBOC clearly intends to help guide the interest rates and manage market liquidity, the effectiveness of the recent policy measures may be limited.

"The PBOC is being front-footed in terms of trying to make sure that there is abundant liquidity as well as to put a floor to the yields," Omar Slim, co-head of Asia fixed income at Pinebridge, said in a media briefing on Monday, referring to the PBOC's sovereign bond borrowing announcement last week.

"It might not change things structurally in the sense that it will not have a long-term impact," he said.

The inverted yield curve - in which short-term debt instruments have a greater yield than longer-term bonds - suggests that investors have "a very low expectation" on China's growth outlook and inflation drive, said Suen. "While rates may not go much lower in the near term as the central bank pushes back against the bond rally, we are of the view that CGB yields could stay low in the medium term, given the current underlying economic conditions."

Goldman Sachs said in a note on Sunday that it was puzzling that the PBOC thinks long-term bond yields should be higher given the weak domestic demand, downbeat consumer and business sentiment and non-existent inflation.

Policymakers engineering increases in long-term interest rates could backfire by tightening financial conditions, hurting growth and further damaging confidence, the US investment bank added.

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