China's central bank shifts focus to overnight rates in liquidity push

China's central bank is sharpening its grip on ultra-short-term interest rates, announcing a shift in its policy target from the seven-day repo rate to the overnight tenor. The move comes alongside plans for significant liquidity injections in the coming days.

The People's Bank of China (PBOC) said it will conduct up to 600 billion yuan ($88.98 billion) of overnight reverse repos per day on August 14 and August 17-19. This pre-announcement is designed to smooth liquidity fluctuations, particularly with the tax payment period approaching, and to prevent sharp swings in money market rates.

Notably, dealers have not used the routine seven-day repo facility for the past three days, according to the PBOC. This follows a similar pause in June. The decision to reduce seven-day operations to zero is seen as a guard against herd behavior in the bond market, which has been rallying on a softening growth outlook and ample liquidity in a banking system flush with household savings.

In its latest quarterly monetary policy report, the PBOC committed to increasing the frequency of overnight reverse repo operations to improve the precision and effectiveness of short-term interest rate management. The report stated that starting in 2025, the target for short-term rates gradually shifted from the seven-day repo rate to the overnight tenor, and since 2026, authorities have further signaled the shift to the overnight rate.

Overnight repo transactions now dominate China's interbank money market, accounting for about 90% of repo turnover. This aligns China with global central banks like the Federal Reserve, which use overnight rates as the primary policy tool to anchor the yield curve. Analysts view this as a continued shift from quantity-based toward price-based monetary policy implementation, with the PBOC likely to keep the overnight money rate in a tighter range around its policy rate.