What’s really driving Chinese property?

From Bank of America Merrill-Lynch comes a short note on what it believes is the real driver behind the Chinese housing market: interbank rates.

The market generally believes that banks are now doing the government’s bidding to support the housing market; we are not so sure. While government’s moral suasion might have played a role, we judge the recent dip in interbank rates and PBoC’s action to maintain inter-bank liquidity as far more influential. We believe that, for mortgage rates to come down significantly, PBoC needs to guide down interbank rates meaningfully. It’s still too early to judge whether this is indeed happening; but, on balance, we remain skeptical…

For [Chinese banks] to be willing to grant more mortgages, they require fairly low funding costs and some certainty about funding source (mortgage is a long-duration loan, not easy for banks to recall when in need of liquidity). The interbank market has become a key source of short term funding for banks in recent years and this is perhaps a major reason why mortgage rates correlate well with 7D repo rate in the interbank market (Chart 2).

Will interbank rates head much lower from here?..

The market is probably expecting this because of PBoC’s continuous OMO to inject liquidity into the inter-bank market and the recent Rmb1tr lending to China Development Bank. However, we don’t think the evidence is conclusive yet. A key reason is that, because of the slow-down of FX inflow, the central bank needs to inject base money to maintain reasonable credit growth. Certainly the interbank rates have failed to react to all these liquidity injections by largely hovering above 3.5% since mid-June.