The People's Bank of China sold 7 billion yuan ($753 billion) of one-year bills in its open market operations on Tuesday and drained another 3 billion yuan via 28-day bond repurchase agreements, compared with a total of 97 billion yuan in central bank bills and repos due to mature this week.
While the central bank will conduct the other regular open market operations on Thursday, traders said mild PBOC activity sparked optimism that the central bank may end up this week with a net injection of funds into the market compared with a net drain of 12 billion yuan last week.
"The liquidity situation has improved and investors are now eyeing conditions after the payment of the latest bank reserve hike," said a trader with a Chinese commercial bank in Shanghai.
"Both money market rates and the short-end of the IRS/bond yields showed some life today, and we look for an improvement late in the week."
The weighted average seven-day government bond repurchase rate , the main barometer of short-term liquidity supply, fell to 4.5993 percent at midday from 4.6631 percent at the close on Monday.
It jumped a combined 188 basis points on Friday and Monday after the PBOC announced its latest hike in banks' required reserve ratios, which will take effect on Wednesday and drain about 370 billion yuan from the financial system.
Another major money market rate, the 14-day repo rate , dropped 17 bps to 4.3542 percent by midday.
Chinese interest rate swaps edged higher on Tuesday but market sentiment was stable as investors kept on the sidelines, awaiting signs of a PBOC benchmark interest rate hike.
The PBOC, however, has given no hints of its next tightening move by keeping the auction yield of its one-year bill sales on Tuesday unchanged.
The benchmark five-year IRS rose 6 basis points to 3.89 percent by midday, while 10-year IRS inched up two bps to 4.12 percent.
The PBOC kicked off a new monetary tightening cycle last October, having since raised official interest rates four times and bank reserve ratios eight times as it fights inflation. Annual consumer price inflation in April eased a touch to 5.3 percent from a 32-month high in March of 5.4 percent.