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China's stock market has soared to multi-year highs since the central bank cut benchmark interest rates last month, as stock investors anticipate more aggressive easing steps to come.
But a funny thing happened on the way to loose money: actual interest rates rose.
The seven-day bond repurchase rate, a key gauge of liquidity in China's money market, touched 7.55 per cent on Wednesday, the highest since late January, when rates traditionally spike ahead of the lunar new year holiday. Yet in spite of rising rates, the People's Bank of China skipped open market operations on Thursday for the seventh straight session.
"The PBoC could have stepped up liquidity injections through open market operations or unconventional tools, but they've chosen not to," said Wei Yao, China economist for Société Générale. "If the [stock] market expects the PBoC to flood the system with cash to support growth, I don't think that's realistic."
But the behaviour of China's stock market has left little doubt that easing expectations — rather than optimism about the real economy or corporate earnings — are driving the rally.
The Shanghai Composite Index rallied on Tuesday after a manufacturing survey showed contraction in the sector for the first time since May, as investors bet the weak data would raise the odds of more stimulus. The market closed at a four-year high on Wednesday.
The jump in market interest rates contrasts with the response to previous benchmark rate cuts.
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The seven-day repo rate ended Wednesday 0.23 percentage points above its level on the eve of last month's rate cut, on a weighted-average basis. At the same point following the PBoC's previous rate cut, in July 2012, the seven-day rate was 66 basis points lower.
Money-market interest rates do not always track rates on corporate loans and home mortgages, which were the main targets of PBoC's rate cut. But there are also signs that the cost of loans to the real economy has also risen since last month.
The discount rate on 3-month bank acceptance bills has risen to 5.21 per cent from 4.34 per cent before the rate cut, according to Thomson Reuters data. Discounted bills, used mainly by smaller companies, accounted for more than a quarter of new last month, central bank data shows.
Most banks have also shrugged off the cut in benchmark deposit rates and are now offering deposits at the same rate as before, and in some cases higher. That is because the rate cut was paired with a parallel move offering lenders greater flexibility to offer actual deposit rates above the benchmark.
Bond yields also spiked last week when a major clearing house announced it would no longer accept low-rated bonds issued by local government financing vehicles as collateral for repo loans — effectively disqualifying about 500 billion yuan ($80 billion) in bonds for use in repos.
Temporary factors have played a role, too. A slew of initial public stock offerings scheduled for next week has raised demand for short-term loans. Bank of America-Merrill Lynch estimates IPO subscriptions could freeze more than 2 trillion yuan in cash until after Christmas. Year-end cash demand as banks try to window-dress their financial statements has also contributed to the rate rise.
Still, traders say the central bank's relative passivity amid the seasonal rise in rates reflects authorities' efforts to avoid stoking easing expectations.
"They'd prefer to use behind-the-scenes measures to direct cash at individual banks that may seriously need it," said a rates trader at a major state-owned bank in Shanghai. "They don't want things to get too loose."