China’s central bank is stuck in a policy dilemma

Fighting the PBOC. At least traders now know for sure where the People's Bank of China stands. The Central bank said on Monday that it would start intervening in short-term debt markets, a week after revealing it was prepared to borrow and sell longer-term government securities. All else being equal, the moves ought to help fulfil one of the institution's mandates - maintaining a stable currency. But it'll probably come at the expense of its other chief directives, fostering economic growth.

Helping with the latter would ideally mean cutting interest rates. That ought to have two related impacts. First, it would make government debt less appealing to investors, who in recent weeks have piled into it seeking a safe haven. The knock-on effect would then be to prompt buyers to put their money to more productive use.

Trouble is, that would effectively mean giving in to the traders who have piled into the bond-buying spree, betting that the PBOC would have no choice but ease monetary policy.

It would also entail rejecting two of the core elements President Xi Jinping said at the start of the year that China should strive for as a "financial power": a “strong currency” topped his list and a “strong central bank” came second.

The yuan has had a tough time of late. It has weakened more than 10% against the dollar since the Federal Reserve began raising rates in March 2022. That has left it trading close to a trough against the greenback not seen since 2007.

The PBOC's new measures may help. These involve conducting temporary bond repurchase or reverse repo operations - whichever is deemed necessary - to ensure “reasonable and sufficient liquidity” in the banking system. That'll tighten the band within which rates trade, giving the central bank greater control.

It would be the first time in almost a decade that the PBOC has deployed these tools. The balance-sheet runoff the bank is forecasting with its two latest moves sends a strong signal that no rate cuts are on the cards.

It's a tricky dilemma to be stuck in. The bank's governor, Pan Gongsheng, will be hoping policymakers meeting at the Communist Party's Third Plenum next week will help solve it for him.

Context News

The People’s Bank of China on July 8 said it would start conducing temporary bond repurchase or reverse repo operations to ensure “reasonable and sufficient liquidity” in the banking system. The central bank will carry out the operations between 4 pm and 4.20 pm Beijing time during weekdays, with overnight terms if necessary. The rates will be set at 20 basis points below and 50 basis points above the seven-day reverse repo rate. The new mechanism to influence short-term rates came a week after the PBOC’s announcement on July 1 that it would start to borrow sovereign bonds from primary traders in the open market “in the near future”.