China’s Central Bank Hints at Major Policy Shift

A speech by China’s central bank chief signals that it is looking to update its monetary tool kit with potential changes that economists say herald a major policy revamp, bringing it closer to practices adopted by its western peers.

Pan Gongsheng, governor of the People’s Bank of China, said Wednesday that the monetary authority might restart trading Treasury bonds in secondary markets, a policy shift that could rewrite the way Beijing manages liquidity.

Over the past decade, the PBOC has mainly relied on various lending facilities and cuts to banks’ reserve requirements to ease monetary settings. But growing constraints on its current range of policy tools have necessitated bond trading by the central bank, a common practice in more advanced economies, analysts say.

Apart from bond trading, Pan also hinted at simplifying China’s current policy rates to allow a single short-term rate to play a bigger role in guiding banks. Pan said he is also considering narrowing China’s so-called interest-rate corridor, which regulates market-rate fluctuations.

“In our view, this clearly indicates a reform in monetary policy objectives and instruments over the next few years,” Xing Zhaopeng, a China strategist at ANZ, said in a note Wednesday. That said, the market impact of such reforms will likely be gradual because the changes can’t be done immediately, Xing added.

It remains unclear whether the central bank would introduce a new short-term rate as the primary policy rate, after Pan said Wednesday that the rate of the seven-day reverse repo operation has basically taken on this role.

This suggests that the closely watched rate of China’s medium-term lending facility may be played down or even phased out in the future, economists say.

The MLF operation could also play a smaller role in terms of liquidity injection, which would be offset by an increase in the PBOC’s purchases of Treasury bonds in its open market operations in the medium term, Nomura economists said in a note.

Central banks in major economies mainly focus on managing short-term rates, and it is usually more effective for the market to determine longer-term interest rates, PBOC-affiliated Financial News on Wednesday quoted an unnamed expert as saying.

The loan prime rate, the country’s benchmark lending rate, doesn’t necessarily need to be linked or referenced to the MLF interest rate, the newspaper said, citing an unnamed source.

Noting that market rates are now able to operate smoothly around policy rates and that the range of rate fluctuation has narrowed significantly, Pan also said China’s interest-rate corridor would likely need to be narrowed to better guide the market.

China’s exceedingly wide interest-rate corridor currently spans 245 basis points. The new corridor could be narrowed to 100 basis points, said ANZ’s Xing.

Pan also said the PBOC would play down other quantitative targets, such as total social financing and money supply growth, in order to focus more on interest rates. The link between economic growth and credit expansion has weakened in recent years in China amid declining loans to the property sector and local government financing vehicles, economists say.

Pan’s comments signal that weak money and credit data may not necessarily trigger further monetary policy easing, as was done by the PBOC in the past, Goldman Sachs economists said in a note.

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