Trading in bonds by China's central bank wouldn't be a form of massive monetary easing, according to its governor, as he responded to speculation that Beijing is eyeing the unconventional policy tool to prop up the economy.

The People's Bank of China and the finance ministry are studying ways to include treasury bond trading in its policy tool kit, said PBOC governor Pan Gongsheng in a finance forum on Wednesday. He rejected the notion that the practice would be equivalent to quantitative easing, when monetary authorities load up on assets like government bonds to push down yields after exhausting more traditional policy tools.

Instead, the PBOC's bond trading will be a liquidity management tool involving both buying and selling, Pan said. Such trading would be a gradual process, and the pace of issuance, maturity structure and custody mechanism for China's treasury bonds will also need to be optimized, he added.

Pan's comments came as a speech from President Xi Jinping in October stoked speculation in recent months that the PBOC could resume trading treasury bonds in secondary markets, a policy option the bank has rarely adopted over the past two decades.

China's central bank isn't allowed to directly trade government bonds on the primary market and has generally refrained from doing so in secondary markets. Instead, the bank injects liquidity into the system via various lending facilities to financial institutions using government bonds as collateral, and has often lowered the amount of cash banks must hold as reserves.

While there is still scope to trim those reserve requirements, economists say it has become increasingly narrow, necessitating more-frequent bond trading by the PBOC as China's bond market matures.

Markets have been watching for signs of PBOC bond purchases since President Xi's speech, but it looks like it may enter the market as a seller instead, to tame an extended rally in bonds. The PBOC-affiliated Financial News reported late May that the central bank will sell treasury bonds when necessary and that falling yields mean it isn't a good time for the bank to buy.

The PBOC has stepped up warnings about the fall in China's long-term yields in recent months. Yields have been pushed to record lows as bonds rally on safe-haven demand amid the slump in the property sector and stock-market volatility. That may have prompted comments from Pan indicating he is uneasy with the rally. He warned that special attention will be paid to non-bank financial institutions which stockpile large amounts of longer-term bonds, and cautioned against maturity mismatches and interest-rate risks.

Pan also sought to downplay the recent slowdown in China's credit growth, which some analysts say point to economic weakness. The huge size of China's existing credit stock, coupled with factors including falling loans to the property sector and local government financing vehicles, mean that maintaining above-10% credit growth would be hard, according to Pan.

The PBOC will also consider widening the scope of a key measure of money supply known as M1 to include individual demand deposits and other highly liquid financial products, Pan said.

Pan's remarks came after China's M1 gauge, which includes cash in circulation and corporate demand deposits, fell 4.2% compared with the same period a year earlier in May, the steepest drop since such data was first published almost three decades ago.

Economists mostly say the M1 contraction was partly because of an outflow of bank deposits that started in April as policymakers looked to reduce excessive liquidity. The PBOC in recent months has cracked down on preferential deposit rates that banks give to companies to park their cash. A lot of these funds have been moved to buy wealth management products and government bonds, economists say.

Including individual demand deposits in the M1 gauge will help iron out the volatility when measuring money supply, said economist Luo Zhiheng at brokerage firm Yuekai Securities. China's M1 in May would have dropped 0.8% on year if individual demand deposits were included, compared with the official 4.2% decline, Luo said in a note this week.

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(END) Dow Jones Newswires

06-19-24 0304ET