China’s Central Bank Moves Toward Overnight Rate System in Major Monetary Policy Reform

China's central bank will begin conducting overnight reverse repurchase operations every working day from November 2, marking a significant adjustment to its monetary policy framework as Beijing moves closer to using the overnight interest rate as its main policy benchmark.

The People's Bank of China (PBOC) announced on Friday that the new operations will use fixed-rate, quantity-based tenders, with the current overnight reverse repo rate set at 1.25%. The move is intended to improve the management of short-term interest rates and strengthen the transmission of monetary policy through China's financial system.

According to Reuters, the newly disclosed 1.25% rate is below the existing seven-day reverse repo rate of 1.4%. The announcement represents a further step toward making the overnight rate the central reference point for short-term liquidity management.

Under the revised framework, the PBOC will also change how it conducts seven-day reverse repo operations. These will move to fixed-quantity, interest-rate-based tenders with multiple winning rates and will mainly be conducted around tax-payment periods and at the end of each month, when liquidity conditions can be affected by seasonal funding requirements.

Other liquidity instruments that were previously priced at a spread relative to the seven-day reverse repo rate will also be linked to the overnight rate. The PBOC said the existing spreads would remain unchanged, meaning the main adjustment concerns the reference rate used to calculate the pricing of these operations.

The overnight reverse repo instrument was introduced in June as an additional tool for managing liquidity in the banking system. By conducting these operations daily, the central bank is seeking to establish a more consistent mechanism for influencing short-term borrowing costs.

The change brings China's monetary operating framework closer to systems used by major central banks, including the US Federal Reserve, the European Central Bank and the Bank of Japan, where overnight rates play an important role in guiding money-market conditions.

Zhou Hao, chief economist at Guotai Junan International, described the announcement as a particularly clear indication of the PBOC's direction, according to Reuters. The shift could also create conditions for more diversified loan-pricing benchmarks and improve the transmission of changes in monetary policy to the wider economy.

China has been gradually reforming its interest-rate system over several years. The loan prime rate, introduced in 2019 as a key reference for bank lending, is influenced by market rates and policy guidance. The PBOC has also increasingly relied on market-based liquidity operations to manage funding conditions rather than relying solely on administrative adjustments.

A more clearly defined overnight benchmark could help financial institutions assess short-term funding costs and price financial products more consistently. It may also provide policymakers with a more direct way to signal changes in monetary conditions without necessarily changing every policy rate at the same time.

However, the announcement does not constitute an immediate broad interest-rate cut. The overnight operating rate has been set at 1.25%, while the seven-day reverse repo rate remains at 1.4%. The practical effect will depend on how banks, money-market participants and other financial institutions adjust their funding and pricing decisions.

The reform comes as policymakers seek to support economic activity while maintaining financial stability. China has continued to use targeted lending facilities and liquidity operations to support technology development, smaller businesses and other priority sectors.

For investors, the next important indicators will include overnight interbank borrowing rates, the results of the first daily operations under the new system and the extent to which the revised framework influences bank lending costs.

The PBOC's decision marks an important technical change in the country's monetary policy system. Its longer-term significance will depend on whether the overnight rate becomes a more effective benchmark for financial markets and helps improve the transmission of monetary policy to businesses and households.