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China acts to ease credit crunch - why the change of heart?

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China's central bank on Tuesday did something it hasn't done in five months: it actively injected cash into local money markets, easing concerns of a repeat of the credit squeeze last month that sparked panic in global markets.

The People's Bank of China (PBOC) pumped in 17 billion yuan ($2.7 billion) into the money markets via seven-day reverse bond repurchase agreements. It was the first time the central bank has participated in open money-market operations since June 20 and the first time it has injected funds since early February.

"I see the levels [of the repo operation] more as a shift in the PBOC's stance to actively managing money market conditions to avoid a re-run of the liquidity squeeze in June," Societe Generale economist Wee-Khoon Chong said in a note.

(Read more: Forget growth, China is contracting, experts say)

"[It] could also serve as a signal that the era of ultra-loose and easy money is over and liquidity has to be appropriately priced (with some leeway of course)," he added.

Analysts said the central bank was motivated to act after the benchmark seven-day repurchase rate spiked to 5 percent on Tuesday for a second straight session following a jump to 4 percent on Friday. It was just below 5 percent on Tuesday, edging down after the injection of funds by the PBOC.

"The central bank reacted to the excessively tight money market conditions - a signal that monetary policy wants to support growth. This is positive for Chinese equities and bonds," said Dariusz Kowalczyk, senior economist for Asia ex-Japan at Credit Agricole.

(Read more: China fires growth salvo, is monetary easing next?)

Banking stocks certainly cheered the news. Mid-sized lender China Merchants Bank led gains by 2 percent while China Minsheng Banking and Pudong Development Bank rallied over 1 percent in Shanghai, outperforming a 0.7 percent gain in the broader market, and after tumbling as much as 3 percent on Monday.

All about stability

Tuesday's cash injection left traders wondering why the PBOC was acting now, when it chose not to ease tight credit conditions a month ago. Money markets rates spiked to record levels in June, with the central bank choosing not to alleviate tight credit conditions in a bid to force local lenders to rein in rampant credit growth.

(Read more: Shadow banking bolsters China as credit tightens)

But fears that the credit squeeze could spillover into the broader economy and accelerate a slowdown in the world's second largest economy sparked panic that hit equity markets globally.

Kowalczyk said Tuesday's move by the PBOC was also aimed at stabilizing liquidity conditions amid increased capital outflows.

Data from the central bank last week showed that foreign exchange purchases by financial institutions - a major indicator of capital flows - fell $6.6 billion in June.

"Corporate clients have been sending more dollars abroad than they received, which is a game changer for money markets because inflows have been a key focus of liquidity," said Kowalczyk. "Now that it's reversed, conditions have tightened. And now, the PBOC is just trying to provide substantial liquidity."

(Read more: Is China right to brush aside credit squeeze?)

More intervention?

Tuesday's money market operations sparked hopes of further cash injections by the PBOC.

"We continue to see the central bank stepping up liquidity injections into August, given the sharp decline in the oncoming liquidity trajectory," said Steve Wang, chief China economist at Reorient Research.

However, the likelihood of future cash injections is likely to depend on the pace of outflows and whether money market rates decline on their own, analysts said.

(Read more: China risks following Japan into economic coma)

"It is not an easy task to engineer major market reforms with minimal volatility. Maintaining relatively stable money market conditions is a way forward," said Societe Generale's Chong.

By CNBC.com's Nyshka Chandran. Follow her on Twitter @NyshkaCNBC

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