China Shuts Liquidity Tap for the First Time in 2 Years

This is a rare move that shows persistently ample liquidity in the banking system after months of subdued credit demand and falling market rates, and which can be interpreted as a subtle signal that policymakers are becoming more cautious about excessive monetary easing and may be looking to encourage idle funds held by banks to flow more directly into lending and broader economic activity amid a fragile recovery in domestic demand.

China’s central bank halted its daily liquidity injections on Wednesday for the first time in almost two years, in a move market participants said reflected abundant cash in the banking system and a push to encourage funds into the wider economy.

The People’s Bank of China (PBOC) said the volume of its seven-day reverse repurchase agreement operations was zero on the day, “in response to the needs of primary dealers in open market operations,” according to an online statement.

It marked the first time since August 2024 that reverse repo operations had fallen to zero, according to Reuters calculations.

“Today’s PBOC operation is surprising,” said Xiaojia Zhi, chief China economist at Credit Agricole.

It came at a time “China rates declined quite notably … The lack of bank credit growth and too rapid lowering of rates could have prompted the PBOC to send a rare warning signal to the markets.”

The volume-weighted average rate of the benchmark seven-day repo in the interbank market, a key gauge of liquidity conditions, traded at 1.33% on Wednesday and has mostly remained below the PBOC’s reverse repo policy rate of 1.4% over the past month.

“Liquidity conditions remain quite ample at this point, perhaps prompting the PBOC to refrain from further injections,” said Lynn Song, chief economist for Greater China at ING.

“Unless we see an extended pause, it is likely only looking at the short-term liquidity environment rather than signalling a shift in the broader monetary policy direction.”

Bond markets showed limited reaction, with the yield on China’s 30-year government bond rising one basis point to 2.2%.

Market participants and economists broadly expect the PBOC to maintain an “appropriately loose” policy stance for the remainder of the year, as policymakers seek to support an economy weighed down by weak domestic demand and external uncertainty linked to geopolitical tensions.

The central bank had instructed banks to boost lending last month, according to sources, after an unexpected fall in credit growth in April.

“We think the PBOC would still maintain its monetary policy stance accommodative, and make more of a push to encourage bank lending and credit growth in near term,” Credit Agricole’s Zhi said.

That stance contrasts with tightening signals in some other economies, where policymakers are grappling with inflationary pressures linked to energy price shocks.

“Unlike many other Asian economies looking at rate hikes, China is yet to face this pressure as inflation is rising from deflation to low positive inflation,” ING’s Song said.

“A rate cut could become more palatable if we get a resolution to the Iran war, and confirmation that energy prices have peaked,” he added, pencilling in a 10-basis-point rate cut in the fourth quarter.

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