The chart compares the recent rise in China’s one-month repo rate – a representative market interest rate – with movements over May-August in the last three years. There is a seasonal tendency for liquidity to tighten during June, with the repo rate peaking in the final week of the month before easing back to a “normal” level by mid-July.
The liquidity shortage this year has, clearly, been much more severe. This could, as some commentators suggest, reflect a balance of payments deficit caused by an outflow of “hot” money. More likely, the authorities have allowed seasonal tightening to develop into a squeeze in order to send a warning signal to banks to curb off-balance-sheet credit expansion, which continues to fuel property speculation. (Another view is that banks are increasingly worried about the creditworthiness of their counterparties but this would not explain rising rates on secured repo lending.)
The seasonal pattern suggests that the one-month rate will start to fall this week, with a larger decline next week. Today’s reversal may mark the start of this process. Economic and market prospects depend importantly on where the rate settles in mid-July. The bias here is to expect a large fall, on the view that the authorities remain in control and will not allow a sustained tightening of monetary conditions given sluggish growth and little inflationary pressure outside housing.
