(Bloomberg) — China’s increasing determination to defend its currency against a strong dollar has worsened a liquidity squeeze in the country, pushing a key short-term funding rate to its highest level in more than a year.
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The cost of borrowing cash via seven-day interbank pledged repurchase contracts — a popular funding tool used by financial institutions — spiked this week to its highest level since October 2023. The spread between the rate and the central bank’s own reverse repo reference rate is now at its widest point since early 2021.
The funding squeeze is a sign of China’s increasingly fraught attempts to stimulate its economy at the same time as stabilizing its currency. The People’s Bank of China unleashed a monetary stimulus blitz last September in an attempt to boost the economy — and is now pushing back against a yuan slide that has been exacerbated by lower yields.
China expanded its support for the yuan this week with measures including tweaks to its capital controls and a verbal pledge to crack down on market disruption. Last week, the central bank unexpectedly said it would suspend its purchases of government bonds, in a bid to curb a debt-buying frenzy.
“The PBOC is carefully managing the pace of liquidity provision, now that currency stability becomes a priority,” Zhou Guannan, an analyst at Huachuang Securities, wrote in a note.
Borrowers got a reprieve on Tuesday afternoon, when Chinese officials held a press conference stressing their goal to keep the yuan stable — but added that they would also take steps to maintain liquidity in the financial system. China will use monetary tools such as interest rates and the reserve requirement ratio to keep liquidity ample, Xuan Changneng, deputy governor of the PBOC, said at the briefing.
READ: China Reiterates Goal to Keep Yuan Stable as Pressure Grows (1)
The liquidity squeeze sent overnight borrowing rates for some non-bank firms to as high as 8% during Tuesday trading, but these rates retreated to around 2% near the end of the day, according to traders who asked not to be identified because they aren’t authorized to speak publicly on the matter.
Uncertainties remain over how the central bank will fill in a liquidity gap ahead of Lunar New Year holidays, wrote Huachuang’s Zhou, estimating the gap to be around 1.5 trillion yuan ($205 billion) this month.
The yuan has come under heavy pressure from the dollar, which has surged amid bets on strong economic data and expectations of inflationary poliices under a Trump presidency. The offshore yuan was trading at around 7.3482 per dollar on Tuesday, after trading below 7 in late September.
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Seasonal flows are exacerbating the liquidity squeeze. Demand for cash tends to increase ahead of the week-long holiday, which this year begins on Jan. 28. Chinese residents typically draw more cash from banks to prepare for spending and traditional gift-giving. Maturities from a PBOC lending facility and tax payments also drain cash from the banking system.
Traders are watching how far the PBOC will tolerate a spike in borrowing costs which may weigh on corporate debt issuers and banks at a time when cheap funding is required to sustain China’s fragile economic growth.
The PBOC is likely to step up liquidity through 14-day reverse repo into festive period, said Wee Khoon Chong, a senior market strategist at BNY. The central bank is likely to deliver more stimulus via cuts to interest rates or reserve requirement ratios later this year, he said.
The overnight repo rate has also ballooned this week, hitting its highest point since June.
–With assistance from Iris Ouyang and Jing Zhao.
(Adds details of press conference in the sixth parapraph, updates prices)
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