China’s monetary policy modernisation accelerates

The People’s Bank of China (PBoC) formally began conducting daily overnight reverse repo operations in November, marking a formal transition towards an overnight policy-rate framework that PBoC Governor Pan Gongsheng outlined in October. The move reinforces China’s transition towards a more market-oriented and interest rate-based modern monetary policy framework. We plan to adopt the overnight reverse repo rate as China’s policy-rate benchmark in our Global Economic Model in the coming months.

The transition itself is unlikely to deliver substantial near-term stimulus and hence has very limited impact on our near-term growth outlook. Persistently subdued inflation could further constrain its effectiveness by keeping real interest rates elevated, and weak private credit demand continues to limit the effectiveness of lower borrowing costs in stimulating the economy.

Nonetheless, our empirical analysis provides tentative evidence of strengthening monetary transmission as the reforms progress, particularly at the short end of the government bond yield curve. That said, the transmission to longer maturities remains much weaker.

The longer-term effectiveness of these reforms will depend on the broader adoption of market-based interest rate benchmarks, more predictable policy communications, and better coordination with structural monetary facilities and fiscal policy.