* PBOC operations signal RRR hike possible, but not rate hike
* Short-term market rates jump but long-term yields stable
* Key money rate heads for highest close in over 2 years
* 7-day repo rate at 3.72 pct vs 2-year closing high 3.64 pct
* 5-year IRS flat; 5-year bond yield inches up 3 bps
By Lu Jianxin and Jacqueline Wong
SHANGHAI, Dec 17 (Reuters) - China's short-term market rates jumped but long-term yields remained stable on Friday, causing the yield curve to flatten sharply as the market factored in another bank reserve requirement ratio (RRR) rise at the weekend.
Worries over official monetary or liquidity tightening steps have become a chronic phenomenon in Chinese markets ahead of a weekend since late October, when the People's Bank of China surprised the market by raising official interest rates, following through with a slew of RRR hikes.
This week, the central bank kept the auction yields of its bills in its regular open market operations unchanged -- a sign that it prefers to use quantitative tools to another interest rate rise for now.
The PBOC sold few bills this week as yields are much higher in the secondary market than in its auctions, and also refrained from soaking up money via repos, indicating that if there is fresh quantitative tightening, it will not go through the open market but via another RRR rise. [ID:nTOE6BF016]
"Policy trends appear quite clear-cut for now and the market reponded accordingly," said a senior trader at a Chinese commercial bank in Shenzhen.
"Short-term market rates are likely to pull back early next week if a RRR hike does not happen over the weekend, while the long end of the curve has little potential to move sharply."
FUNDING CHANNELS APPEAR DIVERSIFYING
The weighted average seven-day government bond repurchase rate CN7DRP=CFXS, the main money market rate, rose 31 basis points to 3.72 percent at midday, heading for its highest close in more than two years now at 3.64 percent, hit on Wednesday.
More significantly on Friday, however, was that the secondary market yield of three-month central bank bills CN3MTB=RR jumped 77 bps to 2.7000 percent.
The one-year bill yield CN1YTB=RR rose 29 bps to 2.8500 percent as traders reported market players were using a greater variety of products to raise funds due to a more than 200-bp spike in the benchmark seven-day repo rate since early November.
Continuous cash drains via RRR hikes have kept liquidity in China's money market under tight conditions, pushing money market rates sharply higher recently.
But there was little excitement among other tenors partly because longer-term market rates had already factored in too much anticipation of official rate increases, traders said.
Five-year interest rate swaps (IRS) CNYQB7R5Y= were unchanged at 3.81 percent at midday, while 10-year IRS CNYQB7R10Y= inched 3 bps lower to 4.02 percent.
The benchmark five-year IRS now implies four 25 basis-point rises in the coming six months or a year, traders said.
China's consumer price inflation in November stood at a 28-month high of 5.1 percent from a year earlier, signalling that a potential rise in rates could still happen in the medium term. Real interest rates have been negative since February.
While many traders believe that chances for a rate rise this year have now diminished, they still expect a rate rise is very possible before the Lunar New Year in early February, a period marked by high consumer spending and strong prices.
In the government bond market, the benchmark five-year bond yield CN5YT=RR edged up 3 bps to 3.57 percent and the 15-year yield CN15YT=RR inched down 3 bps to 3.95 percent.
Current Prs session Change
(Bid, pct) (bps) 7-day repo CN7DRP=CFXS 3.7230 3.4114 +31.16 7-day SHIBOR SHICNYSWD= 3.7008 3.3358 +36.50 90-day CB bill CN3MTB=RR 2.7000 1.9300 +77.00 1-year CB bill CN1YTB=RR 2.8500 2.5600 +29.00 5-year Tsy CN5YT=RR 3.5700 3.5400 + 3.00 15-year Tsy CN15YT=RR 3.9500 3.9800 - 3.00
Note: Repo rate is weighted average.
To see SHIBOR rates, please click SHIBOR
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