China’s financial markets are under pressure for the second time this year. Interbank rates and bond yields have been rising steadily for several weeks and spiked recently when the People’s Bank of China abstained from accommodating seasonal demand for cash.

The PBoC then relented before last weekend and this week. The immediate outlook, while probably volatile, is most likely manageable without too much fuss but the crunch in financial markets symbolises a major and unpredictable policy struggle over the medium-term to tame rapid credit creation, and allow a market-determined cost of capital to emerge.

The simple place to start is the seasonal demand for funds, and normal “window dressing” by banks as they prepare for regulatory assessment. This could last a few weeks and until lunar new year at the end of January. Other factors have also contributed to the tightening of financial market conditions. For example, the build-up in government deposits in the banking system is not being run down as normal to finance government spending growth. This is in keeping with the more sober fiscal stance announced recently after the Third Plenum. Further, financial liberalisation is creating funding demand for initial public offerings in the equity market, with about 50 in the pipeline. It is also driving competition for deposits away from traditional banks and to the relatively new wealth management industry, which originates higher yielding, short-maturity financial products, many of which are up for renewal around this time of year.