China Will Not Reverse Monetary Easing Policies

The reported liquidity drain of over RMB100 billion by China’s central bank does not indicate the start of the country’s monetary policy reversal. China will continue deploying further loosening policies via interest rate cut and bank reserve requirement ratio (RRR) cut, says a BofA Merrill Lynch Global Research report.

The People’s Bank of China (PBoC) reportedly conducted more than RMB100 billion of 7 day, 14 day and 28 day targeted repo transactions with some big banks earlier this week.

China’s stock market reacted strongly to this surprising liquidity drain, and onshore A-shares tumbled by 6.5% yesterday.

But instead of a monetary policy reversal, the action could be requested by banks with ample liquidity to compensate for expensive medium-term lending facility (MLF), says the report.

As of end-April, there were RMB1,079 billion MLF outstanding with yield at 3.50%. It was a good deal for the banks with three-month Shibor at 4.9% in the first quarter and 4.6% in April. But it appears too expensive now with three-month Shibor slumped to 2.7%.

China’s current macro condition requires continued monetary policy easing. First, growth is still weak and inflation is still low. Second, there is still significant room to lower real funding costs. Third, the ongoing local government debt swap program requires accommodative liquidity conditions.

The PBoC has done some easing since November 2014, but the transmission into new credit supply and decline in longer-term yield will take some time.

BofA Merrill Lynch Global Research continues to expect further rate cut of at least one 25 basis point cut and a total of 150 basis point RRR cuts in rest of 2015.

However, the bank says it cannot be ruled out the possibility that the PBoC may wish to use repo as a signal to the market to reduce its excessive speculation on liquidity easing.

Moreover, the PBoC may on the one hand cut RRR to release long-term liquidity and on the other hand fine-tune short term liquidity condition by conducting repo for some reason.

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