LPR follows the reverse repurchase rate to "cut interest rates"! The new monetary policy framework of the central bank is gradually emerging

7-day reverse repurchase "rate cut" and optimization of bidding methods further demonstrate the new monetary policy framework.

On Monday, the central bank announced adjustments to the open market 7-day reverse repurchase operations to fixed interest rates and quantity bidding, effective immediately, to optimize the open market operation mechanism.

At the same time, it was announced that starting this month, institutions participating in the Medium-term Lending Facility (MLF) with demand to sell medium and long-term bonds can apply for phased exemptions of MLF collateral to increase the tradable bond scale and alleviate the supply and demand pressure in the bond market.

To further strengthen countercyclical adjustments, increase financial support for the real economy, the interest rate for open market 7-day reverse repurchase operations is adjusted from the previous 1.80% to 1.70% with immediate effect.

On the same day, the Loan Prime Rate (LPR) in July followed the "rate cut", with the 1-year LPR at 3.35% and the 5-year and above LPR at 3.85%, both lowered by 10 basis points from the previous values.

Zhongzheng Daily pointed out that the downward adjustment of the 7-day reverse repurchase operation interest rate does not mean that there is room for long-term bond yield decline. This rate cut will help support economic recovery, boost medium to long-term economic expectations, and help drive the rise of long-term interest rates.

Analysis believes that after the rate cut was announced by the central bank at 8 am, the LPR reported on the same day quickly responded, following the same adjustment as the 7-day reverse repurchase operation interest rate. This indicates that the LPR quotation is shifting to more reference the central bank's short-term policy rates, and the transmission relationship from short to long-term rates is gradually being clarified.

In addition, the adjustment of the reverse repurchase bidding method to fixed interest rates and quantity bidding also echoes the statement by PBOC Governor Pan Gongsheng to "gradually reduce the quantity intermediary target and shift to price-based regulation".

Previously, the central bank announced the resumption of reverse repurchase operations and included the trading of government bonds in the secondary market in the monetary policy toolkit, further clarifying the outline of the new monetary policy framework. Song Xuetao, Chief Macro Analyst at TF Securities Research, outlined the new monetary policy framework as "guiding medium to long-term interest rates through bond borrowing and lending, and stabilizing short-term rates through overnight repurchase".

LPR follows the same adjustment as the 7-day reverse repurchase operation interest rate

This time, the LPR follows the same adjustment as the 7-day reverse repurchase operation interest rate, decoupling from the MLF. Analysts pointed out:

The MLF rate on July 15 was not adjusted, but the LPR reported on July 22 decreased slightly, indicating that the reference role of the MLF rate on the LPR is gradually weakening, and the policy color of the MLF rate has faded.

The 7-day reverse repurchase operation interest rate has basically taken on the main policy rate function. PBOC Governor Pan Gongsheng previously stated at the Lujiazui Forum that in the future, it may be considered to clearly designate a short-term operating rate of the central bank as the main policy rate. Currently, the 7-day reverse repurchase operation interest rate has basically assumed this function.

At the same time, the central bank announced the adjustment of reverse repurchase operations to fixed interest rates and quantity bidding. Zhongzheng Daily stated:

Open market bidding methods include price bidding and quantity bidding. The bid price in the former is determined by the bargaining between supply and demand, theoretically with uncertainty, while the price in the latter is fixed. In the past, the central bank's open market 7-day reverse repurchase operations used price bidding. Although the bid rate mostly remained unchanged, daily operations were still required to release clear rate signals Considering that the 7-day reverse repurchase operation rate in the open market has basically assumed the function of the main policy rate, in order to enhance the authority of the policy rate and effectively stabilize market expectations, it is necessary to optimize the bidding method to a fixed rate, quantity bidding, explicitly indicating the operation rate. This is also a manifestation of improving the market-oriented interest rate regulation mechanism.

Pan Gongsheng stated that the transition of the monetary policy framework from quantity-based to price-based is an important sign of a modern monetary policy framework. With the development of financial markets and the increase in the level of economic modernization, the process of decreasing the controllability, measurability, and relevance to the real economy of quantity targets, and gradually fading out quantity intermediate targets, is gradually shifting towards price-based regulation. Recently, the total financial data has temporarily declined due to factors such as "squeezing liquidity" and diversion of wealth management, which may indicate that China's monetary policy framework is entering a transitional period, requiring more emphasis on the role of interest rate regulation.

In addition to the adjustment in the bidding method, this time the 7-day repurchase operation rate in the open market has been reduced from the previous 1.8% to 1.7%, marking the first adjustment since August 2023. China Securities Journal pointed out:

The central bank's decisive interest rate cut demonstrates the determination of monetary policy to support economic recovery, which is a positive response to the requirement of the Third Plenary Session of the 20th Central Committee of the Party to "firmly achieve the annual economic and social development goals". Experts believe that the downward adjustment of the policy rate is expected to gradually transmit through the financial market to the real economy, promote the reduction of comprehensive financing costs, consolidate the positive trend of economic recovery, and break the negative cycle of declining long-term bond yields and weakening expectations.

It is worth noting that the downward trend of the 7-day reverse repurchase operation rate does not mean that there is room for a decline in long-term bond yields. The central bank's reduction of the 7-day reverse repurchase operation rate this time aims to increase countercyclical adjustment efforts, smooth short-term economic fluctuations; while the long-term bond yield reflects more of the long-term economic trend, it should be evaluated from a cross-cycle perspective. Industry insiders analyze that the continuous decline in long-term bond rates in this round has already included expectations of this interest rate cut, and even shows signs of overshooting, which does not mean that it is necessary to continue to follow the downward trend of the 7-day reverse repurchase operation rate. The central bank's interest rate cut this time will help support the positive economic recovery, boost medium and long-term economic expectations, and also help drive the rise of long-term interest rates.**

Further Manifestation of the New Monetary Policy Framework

Against the backdrop of China's economy transitioning from high-speed growth to high-quality development, the monetary policy framework is entering a transitional period, placing more emphasis on the role of interest rate regulation.

This time, the Loan Prime Rate (LPR) has been adjusted in the same magnitude as the 7-day reverse repurchase operation rate, coupled with the central bank's announcement of restarting regular repurchase operations, and the central bank announced at the beginning of the month that it will conduct temporary regular or reverse repurchase operations as needed.

In addition, the central bank has clarified the range of points for the temporary repurchase operation rate, aiming to reconstruct the interest rate corridor. The narrowing of the interest rate corridor has entered the practical stage, and the buying and selling of government bonds in the secondary market has been included in the monetary policy toolbox, outlining the embryonic form of the new monetary policy framework.

Song Xuetao, Chief Macro Analyst at TF Securities Research, believes:

The central bank has introduced a new monetary policy framework that guides medium and long-term interest rates through bond borrowing and lending, and stabilizes short-term interest rates through overnight repurchase operations. The narrowing of the interest rate corridor and the strengthening of the position of OMO (Open Market Operations) rates have increased the central bank's control over short-term interest rates.

Borrowing and selling government bonds allow the central bank to better guide the formation of the interest rate curve, maintaining short-term interest rates stable while guiding the formation of an upward yield curve. Meanwhile, the position of MLF (Medium-term Lending Facility) rates continues to weaken.

TF Securities pointed out:

The temporary overnight repo and reverse repo rates are 20 basis points lower and 50 basis points higher, respectively, creating a new interest rate corridor. The overnight repo rate established this time corrects the overly loose interest rate corridor (narrowing the range to 70 basis points), effectively transmitting policy signals to the market and guiding the formation of short-term interest rates.

In addition, regarding bond purchases, analysis from the Financial Times stated:

Pan Gongsheng clearly responded that including government bond transactions in the monetary policy toolbox does not mean quantitative easing, but positions it as a basic currency injection channel and liquidity management tool.

Gradually increasing government bond transactions in open market operations is mainly positioned as a basic currency injection channel and liquidity management tool, actively strengthening liquidity management by trading government bonds in the secondary market to inject basic currency, combined with reverse repos, MLF, and other operations.