China's Central Bank Maintains Tough Stance Amid Liquidity Crunch

China renminbi

China’s seven day repo rate hit a record high of 12% according to Bloomberg, the biggest one-day increase since 2006.

Meanwhile the overnight repo rate was quoted near 25%.

The liquidity squeeze in China first began ahead of the Dragon Boat festival earlier this month. Spikes in interbank rates are common right before holidays. 

But Diana Choyleva at Lombard Street Research said this is symptomatic of a bigger problem. She said capital flows had “become a more important driver of domestic liquidity conditions in China’s managed exchange rate system.”

In a new note to clients Bank of America’s Ting Lu wrote: “There are many factors behind the interbank liquidity squeeze that might be cited, but we believe that the ultimate reason is the central bank’s tough stance as the PBOC can practically provide unlimited liquidity to ease every squeezeif it wishes to.” 

So why isn’t the Chinese central bank stepping in?

As we previously explained the People’s Bank of China seems to be in no mood to support banks’ constant demand for liquidity.

“It seems that the PBoC and some other regulators could be taking the opportunity of the tight funding conditions to ‘punish’ some small banks which had previously taken advantage of the stable interbank rates to finance their purchase of higher-yield bonds,” wrote Lu. 

This also elicited some worrisome responses from some of our favourite China experts on Twitter.

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