PBOC Trying to Keep It Simple With Spotlight on Two Rates

(Bloomberg) -- When Federal Reserve Chair Janet Yellen wants to change the cost of borrowing, investors have one main rate to watch. Her Chinese counterpart Zhou Xiaochuan, who’s been juggling multiple policy levers, is trying to focus market attention on just two.

The People’s Bank of China said late last week that it will now mainly use seven-day reverse-repo operations and the one-year mid-term lending facility for short- and medium-term liquidity demand. It also indicated a range it deems as stable for the seven-day interbank interest rates -- between 2.6 percent and 2.9 percent -- a band much narrower than the broader rates corridor implies.

Zeroing in on two rates helps clarify policy intentions on the road to a more market-based toolkit and could prove vital in constructing a yield curve for securities and loans that’s understood and trusted by investors. If all goes to plan, that should give the economy a more transparent yardstick against which to price risk as the traditional one-year lending and deposit benchmarks are consigned to history.

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"The PBOC wants to simplify the way it provides funds and promote a sense of certainty in markets," said Wang Yifeng, an analyst at China Minsheng Banking Corp.’s research department in Beijing. With a clearer message about the price and maturity of its tools, the PBOC can "reduce the difficulties for commercial banks to manage liquidity and stabilize short-term market rates," he said.

PBOC Governor Zhou for years has been leading a drive to give markets more of a role in the economy, moving away from a model where the central bank decides the amount and price of credit to one where investors determine money flows and steer borrowing costs. The shift is high on an agenda endorsed by top leaders including President Xi Jinping at the Communist Party’s third plenum in 2013, and is seen as a potential catalyst for broader reforms including to the nation’s bloated state-owned firms.

The new focus shows the PBOC is becoming more confident about its monetary policy framework, said Ding Shuang, chief China economist at Standard Chartered Plc in Hong Kong.

Mixed Signals

"The central bank used to control too many points on the yield curve, sending mixed signals to markets," Ding said. "The PBOC seems to have found two most effective ones, and it’ll test if the two have the potential to develop into the new policy rates."

Meanwhile the old rates -- the one-year lending and deposit benchmarks -- have been held at record lows since late 2015 to help cushion the economy’s slowdown. When capital was gushing out of the country last year, the PBOC was reluctant to cut those further for fear of exacerbating outflows. More recently, it has eschewed hiking, preferring to cool the housing market and crimp financial leverage with its plethora of liquidity and lending tools.

"There’s a learning process, since nobody has tried price-based management before - neither the central bank, nor the markets," said George Wu, chief economist at Huarong Securities Co. in Beijing, who worked as a monetary-policy official at the central bank for 12 years. Both markets and the PBOC are trying to make policy evolve "toward a direction in line with international convention," he said.

The PBOC has been building an interest-rate corridor, with the rate for the standing lending facility as the ceiling and the interest on excess bank reserves as the floor. PBOC chief economist Ma Jun in 2015 suggested a target band could be positioned within that broader corridor by using open-market operations.

"The PBOC is giving tacit admission to a preferred range for short-term interest rates" as it points out the range between 2.6 percent to 2.9 percent as being seen as stable, said Ming Ming, a former PBOC official and now head of fixed-income research at Citic Securities Co. in Beijing. "The PBOC will inject or withdraw funds accordingly if the rate moves beyond that range for a relatively long time, as it seeks to ensure interbank market stability."

Huarong Securities’ Wu said it’s still too early to say if short-term rates will definitely stay in the band, since economic and financial conditions can change at any time.

Yet the central bank is "moving toward that goal, toward a corridor in which a pivot sits in the middle", he said.

--With assistance from Zheng Wu

To contact Bloomberg News staff for this story: Yinan Zhao in Beijing at yzhao300@bloomberg.net, Heng Xie in Beijing at hxie34@bloomberg.net.

To contact the editors responsible for this story: Malcolm Scott at mscott23@bloomberg.net, Jeff Black

With assistance from Yinan Zhao, Heng Xie