PBoC likely to stay neutral for an extended period to avoid potential financial bubbles

The People’s Bank of China is expected to stay neutral for an extended period of time, in order to avoid potential property and financial bubbles. The corridor of 7-day repo rate is targeted to centre around 2.25 percent until the end of 2017.

The convention of using the Reserve Requirement Ratio (RRR) and reference interest rates to benchmark China’s monetary policy stands no longer consistent with the market-oriented 'supply-side structural reform', ANZ reported.

Although successive RRR cuts since February 2015 appear to have helped M2 growth by lifting the money multiplier from 4.2 to 5.3 by July 2016, 7-day repo rate has been insensitive to the quantity of money.

If the market interest rate is regarded as a proper signal for resource allocation, RRR adjustment does not seem to have achieved the purpose. Even after successive RRR cuts since February 2015, short-term market interest rates such as the 7-day repo rate have generally stayed at the same level, the report added.

Further, according to the Bank for International Settlements (BIS), the transmission of monetary policy will depend on the link between the key market rate in a jurisdiction and the central bank’s key policy rate. The markets can play a larger role in determining the price signal using the 7-day repo rate as the base rate.

Meanwhile, the PBoC has stressed that they are not an inflation targeting central bank but need to consider many factors in considering monetary policy. Given the lingering debt concern and sluggish growth, the central bank is expected to stay neutral for an extended period. Neither aggressive easing nor tightening is expected until the end of next year, ANZ added.