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China’s central bank is slowing down the pace of monetary easing amid signs of economic recovery, handing disappointment to investors who have worried about tightening liquidity and rising bond yields.

Since early May, the People’s Bank of China has tolerated a steady increase in money market rates and the highest 10-year sovereign bond yield in five months. And although a fresh liquidity injection was signaled by the government two weeks ago, Gov. Yi Gang is taking an unusually long time to deliver.

Instead, Yi has told markets to start thinking about an “exit” from the looser financial policies seen earlier this year, even as the country faces a highly uncertain path out of the historic economic slump in the first quarter. For now, he’s backed by the data — a manufacturing survey released this week points to continued improvement in both demand and supply in June.

Monetary policy is still easing in a broad sense, but there’s been some “partial tightening” compared with the stance in February and March, said Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered PLC in Hong Kong. “The central bank supports economic recovery with eyes on faster credit growth and lower borrowing costs, but it is not to make everyone in the market happy.”

With China’s finance ministry taking the lead in economic policy support this year by issuing a record amount of special-purpose bonds, the central bank is pursuing a far more restrained strategy than global peers. Though intensifying disputes with the U.S. and the risks of a second wave of infection may be prompting officials to save stimulus for worse scenarios ahead, Yi is also warning of the risks of prolonged monetary easing.

“We believe that the financial support policies in response to COVID-19 are phased policies,” he said in a speech in Shanghai on June 18. “We should pay attention to the “aftereffects” of the policies, keep the aggregates at appropriate levels, and consider in advance the reasonable timing of exit for the policy tools.”

Monetary policy is returning to the “pre-COVID approach” of easing that features targeted stimulus, said Liu Peiqian, China economist at Natwest Markets in Singapore. “While ensuring job stability still needs relatively fast credit growth, the loosest moment in monetary policy is behind us, owing in large part to the improving economic fundamentals.”

Indeed, the economy is on track to post a small expansion this quarter, after a slump of 6.8 percent in the first three months. Growth in industrial output and fixed-asset investment are expected to reach a pace similar to the pre-virus level in the second half, according to a recent Bloomberg survey, while retail sales and exports are still contracting.

In its latest move, the PBOC cut the cost of a lending program to lower borrowing costs for small businesses from Wednesday, signaling a continuation in the targeted easing approach. The State Council also pledged to use some of the proceeds from local government debt to buy convertible bonds sold by small banks, in a bid to help them replenish capital and lend more to small businesses.

The next step in reserve-ratio cuts had been expected earlier in June after the State Council, China’s Cabinet, signaled such a move. Normally, the central bank, which is not independent, will act within days to implement the government’s wish.

One reason for policy restraint now lies in regulatory concerns over arbitrage practices, in which companies borrow cheaply from banks and invest in high-yield structured deposits, Bloomberg reported earlier.

The concern had been that some banks were expanding too fast in issuing the products, driven by corporate demand and small banks’ need to take deposits. That would roll back some of the gains in China’s long-running deleveraging campaign.

“There is no doubt that the financial arbitrage may have kept certain liquidity within the financial system, seeking speculative high returns without flowing into the real economy,” Citigroup Inc. economist Liu Li-gang wrote in a note. “This risk should be addressed by using the macro-prudential policies with tightened regulation. In our view, the task to help support the real economy and stabilize growth is a more urgent task.”

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