PBOC Q2 Monetary Policy Report Clarifies Short-Term Interest-Rate Steering Direction

The short-term interest-rate steering target has gradually shifted to DR001, and the next step will be to gradually increase the frequency of overnight reverse-repo operations. In the "2026 Q2 China Monetary Policy Implementation Report" released on the evening of August 12, the People's Bank of China (PBOC) conveyed to the market, through a special column, the measures to improve the short-term interest-rate steering mechanism and the outlook for future reforms.

In the column titled "Improving the Short-Term Interest-Rate Steering Mechanism," the PBOC stated that it will flexibly and precisely carry out various operations, keep overall liquidity at an appropriate level, and better guide the stable operation of short-term money-market rates. In line with primary dealers' needs, the PBOC will gradually increase the frequency of overnight reverse-repo operations to further smooth the transmission from policy rates to market rates.

CICC noted that the monetary policy report removed the phrase "smooth the transmission of monetary policy" from the section "continue to implement appropriately accommodative monetary policy" in its executive summary, and instead devoted a special column to "improving the short-term interest-rate steering mechanism." This reflects that the PBOC's recent reforms, such as narrowing the interest-rate corridor and introducing overnight reverse-repo operations, have begun to play a role in compressing short-term rate volatility and smoothing monetary policy transmission.

On August 12, the PBOC stated that, to better match banks' short-term liquidity needs, it would conduct overnight reverse-repo operations on August 14, August 17, and August 19, with a daily cap of RMB 600 billion.

GF Securities pointed out that the column highlighted the significance of increasing overnight reverse-repo operations: "At month-end, tax-payment periods, and other junctures, some institutions' short-term liquidity needs may last only two or three days. Using overnight operations at these times can improve liquidity-management efficiency and lower financial institutions' costs." This makes it easy to understand why the PBOC conducted four days of overnight reverse-repo operations in mid-August. As the short-term interest-rate steering mechanism continues to improve, money-market rates will more closely hug policy rates, and the policy signals implied by various quantity-based operations and market-rate movements will gradually diminish. Going forward, the focus should be on policy guidance and changes in policy rates.

At the same time, the column analyzed the PBOC's steps since 2024 to improve the short-term interest-rate steering framework and noted that the target rate has gradually shifted toward the overnight money-market rate. Starting in 2025, the short-term steering target shifted from the previous DR007 to DR001, and since 2026 the PBOC has further signaled to the market a clear shift toward an overnight target rate.

Industrial Securities noted that the Q2 report shows the PBOC's liquidity management is becoming more precise. The column traced the evolution of the short-term interest-rate steering framework since 2024 and made clear that "the short-term interest-rate steering target has shifted from the previous DR007 to DR001." This refinement is also reflected in funding rates: since Q2, funding prices have become more stable. The report disclosed that the average DR001 in the first half of the year was 1.31%, and it stood at 1.36% at the end of June, "which is relatively low volatility compared with quarter-ends in recent years, creating appropriate monetary and financial conditions." Going forward, the PBOC may increase the frequency of overnight reverse-repo operations, and starting in August it has already conducted injections during tax periods for the first time. Overnight operations, compared with seven-day operations, can better address one- to three-day funding gaps caused by tax periods and month-end transitions, effectively preventing a build-up of idle funds.

China Galaxy Securities believes that the PBOC has clearly pointed out that the target rate is gradually shifting toward the overnight money-market rate and outlined two directions for further improving the short-term interest-rate steering mechanism. First, "gradually increase the frequency of overnight reverse-repo operations." At times when short-term liquidity demand is relatively strong, such as month-ends and tax periods, the PBOC is expected to gradually increase the frequency of overnight reverse-repo operations. Second, further reduce DR001 volatility and better anchor it around the policy rate to implement more precise steering.

"By introducing the two international models of the Federal Reserve and the ECB, the PBOC is signaling to the market that China is moving closer to international best practices. In addition, the PBOC's announcement of four consecutive working days of overnight reverse-repo operations in mid-August shows a significant improvement in the fine-tuning of short-term interest-rate management. Short-term money-market rates are expected to anchor more closely to policy rates and run smoothly," Caitong Securities noted.