Beijing advances cautiously in a monetary environment marked by an abundance of liquidity and weak credit demand, while concerns about potential distortions in bond markets intensify. At the same time, the world’s second-largest economy faces a prolonged slowdown in several key sectors, notably real estate.
The mission of the People’s Bank of China now leans more toward guiding funds than merely injecting liquidity into the market, while ensuring that such funds do not fuel new financial risks.
Citing sources close to the matter, Bloomberg reported that the People’s Bank of China had asked several financial institutions, notably the large state-owned banks and policy banks, to strengthen oversight of their net lending in the interbank market.
This measure aims to prevent short-term borrowing costs from falling to levels well below the policy rate used by the central bank to steer monetary policy.
According to Bloomberg, the central bank is thus trying to “correct market expectations” regarding liquidity abundance and to preserve the effectiveness of its reference rate as a central tool for steering the economy.
An abundance of liquidity with no real demand
Despite injecting large quantities of liquidity into Chinese markets in recent months, these funds have not translated into a meaningful rise in lending to businesses and households. This situation reveals a deeper imbalance within the Chinese economy.
According to Bloomberg, the weakness of financing demand has led banks to recycle liquidity inside the financial system itself, either by lending funds to each other or by increasing their investments in government bonds, rather than directing them toward productive investments or real consumption.
The Rhodium Group estimates that this behavior reflects the complex transitional phase the Chinese economy is undergoing, during which the real estate sector is gradually losing its role as the main growth engine, without other sectors yet fully compensating for this decline.
The group’s estimates also indicate that weak household and business confidence, combined with persistent disinflationary pressures, have reduced the appetite for borrowing despite the lower cost.
In a report published last May, Reuters indicated that the excess liquidity within the banking system had pushed the day repo rate down to about 1.2%, a level that reflects an historic decrease in short-term funding costs.
Defending the interest rate
In this context, keeping market rates close to the reference policy rate has become an objective in its own right.
Bloomberg reported that the People’s Bank of China had reduced the volume of its daily open market operations to historically low levels, in order to raise the floor of short-term funding rates and to prevent markets from permanently pricing liquidity at nearly zero cost.
These measures have lifted the day-to-day repo rate to around 1.4%, a level consistent with the current policy rate, after dipping to nearly 1.2% in April.
The yield on Chinese 10-year sovereign bonds has also risen to around 1.75%, versus nearly 1.7% at the start of June.
According to The Edge Singapore, Chinese authorities are seeking to restore a balance between available liquidity and real financing demand, after cheap money has become more of a support for bond prices than a tool for economic stimulus.
Fears of a bubble
This development is mounting concern among monetary authorities. Funds that do not reach companies and households return to the financial system through short-term channels or are invested in government bonds, which lowers yields and pushes prices to levels that may no longer reflect actual risks.
According to Bloomberg, the PBOC fears that continuing this dynamic could foster asset bubbles, particularly in the sovereign debt market.
To address these risks, the central bank has used a mechanism known as “window guidance,” an informal tool aimed at guiding the behavior of financial institutions without directly modifying traditional monetary policy instruments.
This approach recalls interventions in China in 2013, when regulators sought to curb the expansion of interbank lending due to risks linked to the shadow banking system.
Crypto Briefing noted that those interventions aimed to contain risks arising from shifting liquidity toward less regulated financial circuits, concerns that reappear today in a different form.
Increased pressure on the weakest players
The large public banks play a central role in the redistribution of liquidity within China’s financial system.
The funds injected by the People’s Bank of China typically pass through these institutions before being transferred to smaller regional banks, then to various sectors of the economy.
With the tightening of restrictions on interbank lending, the smaller institutions could face greater difficulty accessing low-cost financing.
These risks are particularly relevant for real estate developers, local government financing vehicles, and regional banks, which rely more on interbank markets to meet their funding needs.
Rhodium Group estimates that the persistent weakness in the real estate sector has reduced the effectiveness of traditional monetary transmission channels. The abundance of liquidity no longer suffices to trigger a broad credit expansion.
Energy shock worsens the situation
The Chinese monetary equation becomes even more complex with the persistence of pressures tied to global energy markets.
Bloomberg indicated that rising oil prices were increasing import costs and further limiting the PBOC’s ability to cut rates, despite the need for additional economic support.
Reuters also reported that fears of inflation driven by higher energy costs had led markets to push up expectations for keeping policy rates at their current level in the next period.
Rate-cut expectations postponed
These developments have altered economists’ and investors’ forecasts regarding the direction of China’s monetary policy.
According to Bloomberg, several analysts have pushed back to 2027 their forecasts for the next rate cut, due to persistent economic difficulties.
As part of its 2025 Article IV consultations with China, the International Monetary Fund stated that the average inflation rate of consumer prices remained near zero, while producer prices continued to fall.
These data reinforce the idea that the Chinese economy remains faced with internal disinflationary pressures, despite the emergence of inflation risks linked to rising global energy costs.
According to Reuters, Huachuang Securities analysts estimate that the decline of interbank rates below the policy rate reduces the arguments for further rate cuts or for a lower reserve requirement ratio in the short term.
Bond market between support and risks
The bond market has become one of the most sensitive segments of China’s financial landscape.
While government bonds benefited from liquidity abundance and weak credit demand, authorities worry that continuing this trend could lead to an accumulation of financial imbalances that will be difficult to contain later.
Wei Yao, Chief Economist at Societe Generale, nevertheless believes that the yield on China’s 10-year sovereign bonds could fall to around 1.5% in the coming period, due to persistent disinflationary pressures.
Bloomberg cited the economist, saying that the current economic environment remains favorable to a decrease in yields, despite the central bank’s efforts to calm the bond market.
