Pressure on China to withdraw excess funds from the banking system is likely to intensify in March, fed by hot money inflows and a flood of maturing central bank bills, which could spur more aggressive policy steps.
For weeks, expectations of a near-term hike in interest rates have been ebbing as the market approves of China's campaign to rein in bank credit, which has included two reserve ratio hikes and restrictions on lending.
Traders think the People's Bank of China (PBOC) will keep policy stable for the time being to avoid facing strong disapproval during the annual two-week session of the National People's Congress, the largely ceremonial parliament, which starts on March 5.
But the PBOC may have to resort to new measures in the next month or so, such as further reserve ratio increases, guiding up bill yields in its auctions, or adding three-year bills to its weekly bill sales, if it wants to combat an expected marked rise in liquidity that could fuel consumer inflation and asset price bubbles.
“The pressure to withdraw liquidity will accelerate sharply in March, so it can't continue to be so modest in its use of liquidity management tools,” said Liu Jinyu, analyst at China Merchants Bank in Shenzhen.
Expectations of new policy steps may limit how much further longer-term yields can fall in the bond market in coming weeks and add renewed upward pressure on bill yields.
A flood of liquidity into the banking system in February and March will complicate the PBOC's efforts to establish a floor under market interest rates.
The central bank boosted bill yields and repo rates in its open market operations in the first three weeks of January as part of its drive to rein in liquidity.
But it injected a generous net 222 billion yuan ($32.6-billion) in its open market operations in February to ease a funding squeeze ahead of last week's Lunar New Year holiday.
