China central bank switches to daily overnight repo at 1.25%, adopting Fed-style anchor for rates

Daily fixed-rate overnight operations should tighten control over short-term funding costs in China's money markets and reduce the interbank-rate volatility that has occasionally emerged at month-ends and during tax seasons. The shift also changes the focus for traders: the overnight rate is now expected to become the main signal of PBOC policy, making any future change to the 1.25% level a clear policy move. With October PMIs in contraction and equities experiencing their worst month in more than a decade, a more effective transmission channel gives Beijing a sharper tool for lowering borrowing costs if it chooses. For the yuan, the change is structural, not directional, but it updates a framework that global investors have long seen as opaque.

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China is quietly changing the mechanism it uses to guide interest rates, replacing a seven-day benchmark with an overnight one that moves its monetary tools closer to those of the Federal Reserve.

Here is a summary of the changes:

• The People’s Bank of China will carry out overnight reverse repo operations every working day from Monday, using a fixed-rate tender set at 1.25%.
• The 1.25% rate, disclosed for the first time, is lower than the 1.4% seven-day reverse repo rate and generally in line with market forecasts.
• Seven-day operations switch to a variable-rate tender with a fixed quantity, deployed mainly around tax periods and month-ends.
• Other instruments that were previously pegged to the seven-day rate will now be priced from the overnight rate, with spreads remaining unchanged.
• Economists called the move the clearest signal yet that China is adopting an overnight-rate system similar to those of major central banks.

China’s central bank is altering how it determines the cost of money. Starting Monday, the People’s Bank of China will conduct overnight reverse repo operations each working day at a fixed 1.25% rate, a move that brings it closer to adopting the overnight rate as its primary policy anchor in place of its long-standing seven-day benchmark, according to Reuters.

On Friday, the PBOC stated that the daily operations would utilize a fixed-rate tender based on quantity, with the goal of better managing short-term interest rates. It marked the first instance of the bank revealing the overnight operating rate. At 1.25%, the rate is below the 1.4% seven-day reverse repo rate and broadly aligns with market forecasts and actual borrowing costs.

This shift goes beyond mere technical adjustments. For years, the seven-day rate has served as the anchor for Chinese monetary policy, with a range of other instruments priced at a premium or discount to it. Those instruments—including temporary repo and reverse repo operations and repo facilities for overseas central bank-type institutions—will now be priced relative to the overnight rate instead, while maintaining the same spreads. The seven-day operations will persist, but they will adopt a fixed-quantity tender with multiple winning rates and be used primarily around tax payment periods and month-ends.

Put differently, the overnight rate is becoming the central focal point. One economist called Friday’s announcement perhaps the clearest indication yet that the PBOC is moving toward an overnight-rate operating system like those of the Federal Reserve, the European Central Bank, and the Bank of Japan. Another economist noted that the reform sets the stage for broadening the benchmarks used in loan pricing and for transmitting broad-based rate cuts more effectively through the financial system.

The shift had been foreshadowed. In October, PBOC Governor Pan Gongsheng informed a financial forum that the bank was examining a change of its main policy rate to the overnight reverse repo rate. The overnight operations themselves only began in late June, meaning the PBOC has gone from launching the tool to constructing its framework around it in around four months.

The timing stands out. China’s economy is slowing, with official manufacturing and services surveys both falling into contraction in October and equities experiencing their worst month in over a decade. A more transparent, market-driven anchor provides the PBOC with finer management of funding costs and a more direct channel for any stimulus it decides to apply.