China's Central Bank Signals Use of Government Bond Trading for Monetary Policy

China's central bank has stated that secondary market government bond trading can function as a liquidity management reserve and monetary policy tool. This statement comes after comments made by President Xi Jinping that ignited market speculation about a change in China's monetary strategy.

A senior Chinese central bank official suggested that the bank's buying and selling of treasury bonds in the secondary market could be used for liquidity management and as a monetary policy tool. China's treasury bond market has become the third-largest in the world, and its liquidity has improved, making it possible for the central bank to carry out bond buying and selling on the secondary market.

The official stated that China's economic recovery is consolidating, but factors such as supply and demand will also bring short-term disturbance to long-term treasury bond yields. In the future, treasury bond issuance is expected to quicken, and long-term bond yields will rebound.

The People's Bank of China (PBOC) is not allowed to buy bonds directly from the central government and has rarely engaged in large-scale bond buying in the secondary market. Any central bank bond operations will be two-way, highlighting differences with developed countries' bond purchases for quantitative easing purposes.

The Ministry of Finance has also expressed support for allowing the central bank to buy and sell government bonds, further reinforcing the central bank's position on using government bond trading as a policy instrument. Ministry officials said they will look to increase the variety and scale of government bond issuances and improve the efficiency of capital allocation.

Why this matters: This development signals potential shift in China's monetary policy strategy, with the central bank exploring new tools to manage liquidity and implement monetary measures. The use of government bond trading could have significant implications for China's financial markets and overall economic stability.

The PBOC has not made any treasury bond trades since October 2023 and has been cautious about large-scale monetary easing. Economists believe it is unlikely that the PBOC will launch U.S.-style quantitative easing, as it still has room to ease monetary policy through more traditional means while also considering factors like tepid borrowing demand and a weak currency. "The PBOC's bond operations will be two-way, which is different from the quantitative easing (QE) operations of developed countries' central banks," the central bank official stated, emphasizing the distinction between China's approach and that of other nations.

Key Takeaways

• China's central bank may use treasury bond trading as a liquidity and policy tool.
• China's treasury bond market is the world's 3rd largest, with improved liquidity.
• China's economic recovery is consolidating, but factors may impact long-term bond yields.
• China's central bank is not allowed to buy bonds directly from the government.
• China's approach to bond operations differs from developed countries' quantitative easing.