Interest Rates: Why China Did Not Follow the Fed (3 mins)

June 2017

Malcolm Riddell:        Pete, what are we going to talk about today?

Pete Sweeney:            Well, what the chatter in China is over the Central Bank's [the People’s Bank of China, PBOC] decision not to follow the Fed after an expected rate hike and hike in it's own internal rate, specifically the guidance interest rate for the seven day repo, which is the key liquidity indicator. Some people were expecting the Central Bank to do that given the overall need to deleverage or at least moderate the pace of credit growth in China. And, the Central Bank didn't do it.

Malcolm Riddell:        Why do you think they didn't do it?

Pete Sweeney:            Well, there are a lot of balls in the air here. For one thing, the Central Bank is tightening internally through other means. Unlike in the States or more developed economies, in China the market tends to look far more closely at liquidity conditions than the actual formal rates published. That's, a couple reasons for that.

                                      For one thing, you've got the dominant presence of these giant state-owned banks that can be a distorting factor in terms of market pricing. Then there's the Central Bank's strong hand in terms of injecting or withdrawing short-term liquidity through open market operations and the money supply. But those rates have been going up, and they're freely traded. So there's already some tightening going on. But when the Central Bank does move these rates, it is seen as a very strong signal that can rattle people. Maybe that’s why the Bank didn’t follow the Fed.

Malcolm Riddell:        Why is it in China that people look at liquidity rather than rates?

Pete Sweeney:            Well, right, as I said, you can have rate quotes that are coming from giant state owned banks that are indicative more of what the government would like the rate, or the exchange rate say, or the money rate to be rather than the actual conditions of supply and demand in the market, right? So, if you're ICBC, you can put in a quote for the Renminbi at 6.7 or 8.5 or whatever you want in the market, you can bring a bunch of firepower behind that and you can drive the market to where you want it to be. The same is true for money rates.

                                      We've had these cash crunches in China before, and the volume weighted average rate will stay relatively flat, and you'll see wide amplitude, unlike the quotes. What that shows, usually, or often, is that the big five banks are kind of keeping the rates roughly in a stable ground, where smaller banks and other financial players are, in fact, in a panic. So, it doesn't necessarily reflect the cost because the presence of these big players who are able to take a call from PBOC Governor Zhao Xiaochuan and put in the quote that Central Bank would like them to put.

                                      I have no evidence this actually happens, nobody does.

Malcolm Riddell:        I understand.

Pete Sweeney:            But when people talk about Central Bank interfering, that's what they're talking about. They're calling up the People's Bank, they've got their own trading desk as well, but they can call up PBOC and say, "Look, guys, there's some panic in the market yesterday. We want you to open up the market with a big quote that keeps rates lower or raises them higher," depending on the needs of the day.

                                      So, that's one reason. And also just kind of the history of looking very closely at how much liquidity is getting put into the system. There are other reasons, of course, but those are some of the important ones, I think.

Pete  sweeney

Pete Sweeney

Asia Editor, Reuters Breakingviews

Asia Editor Pete Sweeney joined Reuters Breakingviews in Hong Kong in September 2016. Previously he served as Reuters' chief correspondent for China ...

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