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PBOC introduces new interest rate tools

PBOC introduces new interest rate tools

(8 February 2016 – China) The People’s Bank of China (PBOC) has been testing its new "interest rate corridor", reports say.

The corridor may help reduce the need for deeper monetary policy easing by the PBOC.

The central bank introduced a new band to guide interest rates on loans and deposits late last year, removing official restrictions on such rates that market participants had criticised for distorting capital flows.

In its corridor management, the PBOC has set the upper and lower limits of the interbank rate bands at 2.75 percent 2.25 percent respectively, and uses short-term money market instruments to keep the rates within that range.

According to the reports, the central bank has been testing the corridor during the traditional liquidity shortfall ahead of Lunar New Year.

Over the past three weeks, the central bank has pumped more than 2 trillion yuan (A$429 billion) in short-term funds into the markets via monetary tools in a bid to keep rates steady and within the corridor.

It is expected that Beijing could cut banks' reserve requirement ratios (RRR) to soften its economic slowdown, where firms still complain that real interest rates are far higher than returns on investment given the semi-deflationary environment.

However, if the PBOC's repeated injections keep rates stable, the case for immediate RRR cuts could diminish.

By using price targets, rather than supply constraints, to control money supply, a rates corridor reduces the fear factor that has historically overhung China's money market.

Further, the corridor's lower limit helps cushion possible capital outflows, the kind of which China experienced in the lead up to the U.S. Federal Reserve's interest rate hike in December.

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