SHANGHAI: China's interest rate swaps dropped again on Thursday, with the benchmark five-year IRS effectively breaking through a main barrier at 3 percent, as the market shrugged off caution from the central bank that it had not eased monetary policy.

The People's Bank of China was quoted as saying on Thursday that a recent move to revise bank reserve requirement ratios (RRR) for several rural banks did not amount to a cut in their reserve requirements.

Sources told Reuters earlier this week that the PBOC had cut the RRR for five banks in the eastern province of Zhejiang, a centre for private enterprise, by 50 basis points to 16 percent to support the rural economy.

Some investors had speculated that the adjustment was part of a government campaign to relax monetary policy in some quarters of the economy. The talk gained traction after a manufacturing survey showed output at a 32-month low in November.

The market has bet that the PBOC will loosen monetary policy in the past few weeks, but the central bank has acted to cool down hopes of an immediate easing.

"Investors continue to factor in an expected PBOC policy easing in coming months no matter what the central bank says," said a trader at a Chinese stock brokerage in Shanghai.

"The idea is that a slowing global and Chinese economy will eventually enforce a monetary policy relaxation."

The five-year IRS fell 3 bps to 2.93 percent after it fell below support at Wednesday's close for the first time since October last year, when the PBOC launched a new cycle of monetary tightening to fight runaway inflation.

One-year IRS dropped 5 bps to 2.91 percent while the 10-year IRS lost 2 bps to 3.04 percent.

China's money market rates staged a correction after steep rises over the past week as the PBOC is injecting money into the market via open market operations this week.

The central bank refrained from draining money via government bond repurchase agreements on Thursday, and is on course to end the week with a net injection of 22 billion yuan ($3.5 billion) into the market.

Last week, the PBOC conducted a net drain of 2 billion yuan from the market, reversing a net injection over the previous two weeks, as it acted to cool hopes of an immediate policy easing, and that had pushed up money market rates to very high levels.

The weighted average seven-day repo rate fell to 4.1370 percent at midday from 4.3513 percent at Wednesday's close. The overnight repo rate was down at 3.9568 percent from 3.9769 percent while the 14-day repo rate dropped to 4.7059 percent from 4.8960 percent.

Copyright Reuters, 2011

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