On December 25th, the People's Bank of China (PBOC) conducted a substantial 300 billion yuan operation involving Medium-term Lending Facility (MLF) to address liquidity within the financial marketAnalysts observed that with an MLF maturity volume of 1.45 trillion yuan due on December 16th, the decision to execute a reduced-scale MLF operation indicated an ample liquidity environment currently permeating the market, diminishing the necessity for extensive additional liquidity injectionsThe PBOC has diversified its liquidity provision channels, applying operations more judiciously, suggesting that the flow of capital in the market is unlikely to encounter any substantial hindrance in the foreseeable future.

The liquidity landscape this year has notably differed from prior yearsAs the year draws to a close, the overall availability of funds has remained generous, sustaining a comfortable atmosphere for financial transactions

Interbank overnight rates have mostly stayed below 1.5% since December kicked in, showcasing a sound economic backdropAdditionally, the interest rates on one-year interbank certificates of deposit issued by major state-owned banks have plummeted to below 1.7%, indicating abundant funding across different maturities and amounting to a sufficiently relaxed liquidity setting that favors a stable transition into and out of the New Year and the Spring Festival.

One striking aspect of the current situation is the proliferation of liquidity provision tools at the PBOC’s disposal, rendering operations increasingly more calculatedThis year, the central bank's monetary policy toolbox has been notably augmented with the introduction of venue trading for government bonds and the option of reverse repos with special terms, allowing for flexible adjustments under the current macroeconomic context

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By skillfully managing the MLF maturities set to peak in the last quarter, the PBOC aims to reduce the operational burdens related to liquidity sourcing.

In October and November, MLF operations saw net contractions of 89 billion yuan and 550 billion yuan respectivelyHowever, despite these withdrawals, the PBOC successfully net injected long-term funds through government bond transactions and reverse repos during the same periodsThe strategic deployment of these tools has enhanced the adaptability and responsiveness of the central bank’s operationsThroughout December, it is anticipated that transactions concerning government bond sales and reverse repos will far exceed the amount maturing at MLF facilities to sustain the necessary liquidity conditions needed for the market.

Chief Macro Analyst Wang Qing from Dongfang Jincheng insists that the financial landscape is ripe for a package of stimulating policies, alongside a shift in monetary policy tone from 'stable' to 'moderately expansive'. This suggests greater likelihood of larger-scale reverse repos forthcoming from the PBOC, aiming to maintain a reasonable liquidity abundance and stabilize market expectations.

Experts argue that the infusion of new mechanisms such as government bond transactions and reverse repos into the market, replacing traditional MLF operations, play a vital role in lowering financing costs and alleviating the pressure on banks' net interest margins

Historically, every year, the PBOC would amplify its MLF operations to ensure ample liquidity at year-end to uphold a robust and smooth operation within the entire financial systemUtilizing MLF has proven essential in supplying needed liquidity during periods of increased demand.

Contrary to previous years, this year has witnessed a paradigm shiftThe PBOC initially pursued a reserve requirement ratio (RRR) cut to replenish long-term liquidityReducing the RRR means that banks and other financial institutions are required to maintain a lower percentage of reserves, effectively releasing a significant amount of long-term liquid assets into the marketplace, thereby establishing a sturdier monetary foundationFollowing this, the central bank has relied heavily on reverse repos—specifically, the fixed-term reverse repos and the seven-day reverse repos—to further fine-tune the liquidity dynamics within the market.

The unique operational structure of the fixed-term reverse repos permits fund borrowers to sell assets such as bonds to lenders, under an agreement to repurchase them at a specified price upon maturity

This mechanism not only affirms the healthy flow of funds but also enriches the types of transactions occurring within the marketOn the other hand, the seven-day reverse repos, given their shorter term, are inherently more flexible, allowing for fairly precise adjustments according to the current liquidity situationThis flexibility is coupled with comparatively lower rates on these operations, crafting numerous beneficial effects within the economy.

Since the latter half of this year, MLF benchmark rates have been adjusted to reflect a market-driven tendering process, leading participating institutions to take the year’s one-year interbank certificate of deposit rates as a referenceAs a result, the MLF’s benchmark interest rate no longer carries specific policy implicationsFurthermore, recent data suggest that one-year term deposit rates from major and joint-stock banks hover around 1.65%, indicating that bids for MLF among these institutions might not escalate much beyond this threshold; conversely, smaller banks may present higher bid rates reflecting their comparatively weaker financing capacity.

Should liquidity conditions remain favorable, a reduction in MLF operations could allow for bids focused on higher interest rates to take precedence in the tendering process, potentially resulting in higher MLF benchmark rates