Photographer: Qilai Shen/Bloomberg

China Raises Mid-Term Lending Rates in New Signal of Tightening

  • Central bank boosted rates on 1-year, 6-month loan facilities
  • Shift comes amid recovering prices and bid to rein in risk

China increased interest rates on the medium-term loans it uses to manage liquidity, the strongest signal yet of tightening as it shifts focus to curbing risk in the financial system.

The People’s Bank of China raised the one-year Medium-term Lending Facility rate to 3.1 percent from 3 percent and the six-month rate to 2.95 percent from 2.85 percent, it said Tuesday in a statement on its Weibo social media account. The rates are becoming one of the main policy tools as the central bank moves away from old benchmarks.

"As China has essentially liberalized deposit and lending rates, the rates charged on MLF effectively play the role of medium-term policy rates," Ding Shuang, chief China economist at Standard Chartered Plc in Hong Kong, wrote in a report. "Today’s move confirms that monetary and credit policy will likely be moderately tighter this year."

The central bank has increasingly managed the flow of credit with the MLF, a more finely-tuned instrument than changing how much of their deposits lenders must keep locked away. The PBOC’s official newspaper recently said new funding tools used to adjust the flow of credit in and out of the financial system are playing a major role in monetary policy.

With factory prices rebounding after years of deflation and the economic expansion resilient, policy makers have made avoiding financial system risk a key theme in recent months. Top economic officials said last month they plan prudent and neutral monetary policy.

Read More: China Plans Prudent, Neutral Monetary Policy

China should tighten policy as signs of overheating emerge amid quickening inflation, Song Yu, the Beijing-based chief China economist at Beijing Gao Hua Securities Co., the mainland joint-venture partner of Goldman Sachs Group Inc. said in a recent interview. Song is the top forecaster for Chinese indicators, Bloomberg data show.

Policy makers are trying to strike a balance between avoiding excess credit that fuels asset bubbles and keeping enough funding in the financial system amid surging seasonal demand before the start of the Lunar New Year holiday this week. They’re also using new tools as they turn away from old ones like benchmark interest rates and required reserve ratios.

The tweaked MLF rate lacks the punch of an increase to one-year benchmark interest rates -- moves that traditionally are made in quarter or half percentage point increments. The last tightening of those benchmarks came in July 2011.

Read More: PBOC Adopts Mid-Term Credit Tool as Old Benchmark Fades Away

"We believe the reason for the PBOC to raise the MLF is aiming to mop excessive liquidity and prevent potential financial risk in the system, particularly the shadow banking sector," Raymond Yeung, chief greater China economist at Australia & New Zealand Banking Group Ltd. in Hong Kong, wrote in a note.

The PBOC said in its statement Tuesday that the MLF operations injected 245.5 billion yuan ($36 billion) into the financial system. That followed an announcement Friday that it provided a 28-day temporary liquidity facility to some major commercial banks.

Demand for money jumps before the Lunar New Year holidays, also known as the Spring Festival, as families prepare to exchange gifts and meet for feasts. The holiday runs from Jan. 27 through Feb. 2 this year.

Read More: $12,000 Trips Abroad Replace Chinese New Year Treks to Grandma’s

China’s one-year interest-rate swaps, which reflect market expectations for seven-day repurchase rates over a year, jumped 15.5 basis points, the most since March 2015, to 3.28 percent as of 5:40 p.m. in Shanghai. The yield on 10-year government bonds due in November 2026 climbed 7.5 basis points to 3.305 percent, data compiled by Bloomberg show.

The rate increases underscore monetary policy’s shift toward a neutral stance with a slight tightening bias as well as the PBOC’s cautious, incremental approach to avoid fueling market panic, said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong.

"With inflation rising and investment recovering, China’s economy doesn’t need the support of a loose monetary policy anymore," Shen said in an interview. "It’s becoming clear the one-year MLF rate is the policy rate for mid- and long-term lending."

— With assistance by Yinan Zhao, Robin Ganguly, Tian Chen, Xize Kang, and Helen Sun

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