(Bloomberg) -- Signs of a cash squeeze are appearing in China as the quarter-end approaches, underscoring how the nation’s economic rebound is driving demand for loans and prompting the central bank to ease policy.

The overnight repurchase rate, an indicator of interbank funding costs, climbed to the highest level since February 2021 on Tuesday. Short-term liquidity is becoming more scarce in the interbank market, as lenders set cash aside for quarter-end regulatory checks and disburse more loans amid a recovery fueled by a reopening of the economy.

A reduction in the reserve requirement ratio from March 27 is likely to ease the funding squeeze although the People’s Bank of China may step in to offer more liquidity support. When the overnight repo rate soared last month, the central bank pumped in 1 trillion yuan ($145 billion) of funds into the financial system over three sessions. 

“Quarter-end factor may have added to the borrowing stress, but the tightness is likely to be temporary given an RRR cut is on its way, said Li Yishuang, analyst at Cinda Securities. “Before the RRR takes effect, PBOC may continue with flexible open market injections to sooth the borrowing-demand tension in the next few sessions.”

The overnight repo rate rose 17 basis points to 2.45%, while the seven-day tenor was below it at 2.22%, signaling that traders expect liquidity conditions to improve. The rate on top-rated banks’ one-year negotiable certificates of deposits also has declined from a three-month high, suggesting that the squeeze on funding has eased somewhat.

The surprise RRR cut, which was announced on Friday, is expected to release some 500 billion yuan of long-term funding into the banking system, according to some analysts. That would be in addition to the 281 billion yuan of policy loans the PBOC offered versus maturities this month, the largest monthly net injection since December 2020.

The central bank added a net 153 billion yuan into the banking system via seven-day reverse repurchase agreements on Tuesday. Some non-banking institutions faced difficulties in borrowing cash in the morning, but the situation has improved slightly after the open market operation, according to traders who asked not to be named as they are not authorized to speak publicly.

“The wobbles in interbank liquidity have increased as early signs show loan-making into March continues to be robust and issuance of special local government bonds is also likely to pick up pace in March and April,” BNP Paribas SA economists including Jacqueline Rong wrote in a note. The PBOC may lower the RRR by another 25 basis points in the second half of this year, they added.

Credit supply in China grew strongly in February, with local governments selling nearly 1.5 trillion yuan of bonds in the first quarter, close to last year’s record amount of issuance for the same period, according to data compiled by Bloomberg.

--With assistance from Jing Zhao.

(Updates throughout)

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