The People's Bank of China has sent a clear signal of its intent to stabilize market liquidity by simultaneously deploying two monetary policy tools with different maturities.
As the quarter-end approaches, potential disturbances to funding conditions are intensifying. On June 25th, the central bank implemented two key operations. First, it conducted a 500 billion yuan 1-year Medium-term Lending Facility (MLF) operation, continuing to increase the supply of medium- to long-term liquidity. Second, it officially announced the addition of overnight reverse repo operations on June 29th and 30th, fulfilling the commitment to optimize interest rate regulation and control made at the Lujiazui Forum.
The simultaneous use of these short- and medium-term tools underscores the central bank's clear signal to stabilize liquidity.
Medium-Term Liquidity Operations: Contraction Followed by Expansion
On June 24th, the central bank announced it would conduct a 500 billion yuan 1-year MLF operation on the 25th. Given that 300 billion yuan of MLF was set to mature in June, this represents a net injection of 200 billion yuan, marking the second consecutive month of increased MLF rollovers. The scale of the increase was 100 billion yuan larger than the previous month, aligning with general market expectations.
Considering the 300 billion yuan contraction in outright reverse repos of two tenors earlier in June, the central bank's net medium-term liquidity operations for the month resulted in a total contraction of 100 billion yuan. This indicates a process of "contraction followed by expansion" in medium-term liquidity management for the month.
An analysis of the reasons behind this pattern suggests that market liquidity remained relatively loose in early June. The central bank consequently conducted net withdrawals through various short- and medium-term open market operations, including 7-day pledged reverse repos and 3-month outright reverse repos, to guide market interest rates back towards policy rates.
A key context for the increased MLF rollover is that the previously loose liquidity conditions have now been significantly reversed. Starting from mid-June, the overnight repo rate (DR001) rose above the policy rate. On June 15th, the central bank ceased the contraction of 6-month outright reverse repos and switched to a net injection in 7-day pledged reverse repos. Recently, both DR001 and the 7-day repo rate (DR007) have stabilized above policy rates, and the yield on 1-year AAA-rated interbank certificates of deposit has also risen to some extent.
Furthermore, the increased MLF injection also addresses dual demands from fiscal policy and macroeconomic stabilization. Analysts point out that, on one hand, the accelerated issuance of new local government special bonds is driving a significant rise in government bond financing in the final week of June. On the other hand, macroeconomic data has shown some fluctuations since the second quarter. Banks may subsequently accelerate the pace of credit extension for infrastructure and manufacturing investment to help stabilize investment growth.
For the current week (June 22-26), a total of approximately 2.2358 trillion yuan in open market operations is set to mature, comprising 1.9358 trillion yuan in reverse repos and 300 billion yuan in MLF. Combined with a net government bond payment requirement of 0.6 trillion yuan, this creates a conventional funding gap of around 2.8 trillion yuan, which may exert some draining pressure on liquidity.
Experts believe that by using MLF to lock in medium- to long-term liquidity and complementing it with rolling short-term reverse repo injections, the central bank can effectively smooth out significant liquidity volatility around the half-year point. This layered supply of funds helps stabilize overall market risk expectations and ensures the smooth functioning of bond and credit markets.
On June 22nd, 23rd, and 24th, the central bank conducted 476.5 billion yuan, 524.5 billion yuan, and 662.5 billion yuan in 7-day reverse repo operations, respectively, fully meeting the demand from primary dealers.
Overnight Reverse Repo Operations to Commence at Month-End
To better align with the banking system's short-term liquidity needs, the central bank announced on June 25th that it will add an overnight reverse repo operation to its open market toolkit on June 29th and 30th. These operations will be conducted via fixed-rate, quantity-based tenders.
This marks the first practical implementation following the policy announcements made at the Lujiazui Forum. At the 2026 Lujiazui Forum, the central bank governor stated that the bank would optimize the mechanism for temporary overnight repo and reverse repo operations and emphasized the timely addition of an overnight reverse repo instrument.
Analysis suggests that the overnight repo is the most crucial financing tool for institutions and the most actively traded instrument in the funding market. Observing daily transactions in the interbank pledged repo market reveals that overnight transactions consistently account for over 80% of the total, far exceeding other tenors. However, the current 7-day reverse repo rate serves as the core policy rate, creating a maturity mismatch with the market's predominant use of overnight instruments.
The introduction of the overnight reverse repo tool is seen as an effective solution to this maturity mismatch between the 7-day policy rate and the market's overnight rate. During periods like tax payments and month-end transitions, it will help better match the banking system's short-term liquidity needs, enhancing the precision and effectiveness of the central bank's short-term interest rate control.
Market observers note that the decision to introduce this tool specifically for the last two days of the month indicates its current role as a supplement to regular open market operations. Considering that June is typically a month with significant credit expansion, the combined pressures of month-end credit push and liquidity assessments make this move a demonstration of the central bank's supportive stance towards the liquidity environment.
From a long-term perspective, the launch of the overnight reverse repo is a key step in interest rate marketization reform. Analysts outline two potential evolutionary paths. If the central bank increases the frequency and scale of overnight reverse repo operations, short-term market rates might gradually use the overnight policy rate as a benchmark, potentially transforming the interest rate control system into a framework similar to the Federal Reserve's current system, which is dominated by the overnight rate. If the overnight reverse repo is only activated at specific times, the current system centered on the 7-day reverse repo rate might continue, with the overnight tool merely serving to stabilize the short-term funding rate.
From an interest rate perspective, the central bank is likely to maintain a certain spread between overnight and 7-day reverse repo rates. Subsequently, DR001, as a benchmark funding rate, may follow the overnight reverse repo rate more closely. Regarding operation size, the volume will still depend on the actual liquidity needs of financial institutions at month-end. Unlike 7-day reverse repos, overnight reverse repos are conducted one day and mature the next, which could lead to larger operation volumes compared to their 7-day counterparts.
Smooth Quarter-End Transition Remains Anticipated
With multiple funding pressures converging, market attention is focused on the trajectory of funding conditions across the quarter-end. Expert analysis generally suggests that a smooth transition is supported by sufficient policy backing.
Given that short-term market rates have already risen above policy rates, coupled with the approaching quarter-end bank assessments and the potential for accelerated government bond issuance in July, it is anticipated that the central bank's open market operations may maintain a state of substantial net injections leading up to the month-end. The likelihood of market rates deviating significantly and persistently above policy rates is considered low.
Considering historical patterns and current quarter-end funding costs, a smooth transition remains the expected outcome.
Looking at funding price movements on June 25th, the Shanghai Interbank Offered Rate (Shibor) showed mixed changes. The overnight Shibor was quoted at 1.3990%, down 0.90 basis points. The 7-day Shibor was quoted at 1.5130%, down 3.50 basis points. The 14-day Shibor was quoted at 1.5170%, down 1.60 basis points. The 1-month Shibor remained unchanged from the previous session at 1.4300%, while the 3-month Shibor rose 0.35 basis points to 1.4395%.
As of 2:08 PM on the 25th, the weighted average rate for DR007 had fallen by 43.33 basis points to 1.5101%, still above the policy rate. The weighted average rate for DR001 decreased by 1.35 basis points to 1.3984%. The 1-day government bond reverse repo rate on the Shanghai Stock Exchange (GC001) declined to 1.4650%.
Looking ahead to monetary policy operations in the second half of the year, following the period of relatively loose market liquidity, medium-term liquidity policy tools, including MLF, are expected to resume an overall pattern of increased rollovers. This will be a key measure to support government bond issuance in the latter half of the year, reflecting a continuation of the supportive monetary policy stance.
The third quarter is projected to be the peak period for government bond supply this year, potentially increasing the necessity for monetary policy to coordinate with fiscal policy. After consecutive net withdrawals of short- and medium-term funds by the central bank since March, the stock of monetary policy tool quotas has declined. This raises the possibility of subsequent measures, such as a reserve requirement ratio cut, to replenish liquidity gaps.
Comments