“A rate hike on the first working day after the New Year holiday signals a new attitude,” said Raymond Yeung, chief greater China economist at Australia & New Zealand Banking Group Ltd. in Hong Kong. “The PBOC never makes it clear, but the seven-day reverse repo rate is the unofficial policy rate, a significant benchmark for interbank rates.”

One-year interest-rate swaps climbed as much as 12 basis points to 3.43%, the highest since Dec. 28, while the seven-day repurchase rate pared declines to 13 basis points to trade at 2.50%, according to a weighted average. Ten-year government bonds were little changed, while Shanghai shares extended losses to 0.6 percent.

'Tightening Message'

The PBOC's move is “surprising and the tightening message is strong,” said Frances Cheung, Hong Kong-based head of rates strategy for Asia ex-Japan at Societe General. The fact that the whole yield curve rose shows the market is concerned about further deleveraging, she said.

The move will send Chinese bonds into a technical bear market, said Ming Ming, Beijing-based head of fixed income research at Citic Securities Co. Tighter policy aims to further deleveraging, prevent an overheating in credit growth and widen the yield advantage Chinese bonds have over U.S. debt, thereby supporting the yuan, Ming said.

In a Bloomberg News survey conducted in late December, one-third of the 24 respondents predicted the PBOC would increase reverse repo rates, while the rest expected no change. The central bank has also been tightening cash supply since August to curb leverage in the financial system, rein in price gains and support the exchange rate.

Policy Shift

With factory prices rebounding after years of deflation, policy makers have made avoiding financial system risk a key theme in recent months. Friday's moves underscore the leadership's determination to push up funding costs of short-term tenors to rein in leverage and switch to the combination of less monetary stimulus and more fiscal support, after earlier easing fueled bubbles in bonds and the property market.

Tightening via lending facilities and money-market rates shows the central bank's desire to make further progress on liberalizing interest rates, said Iris Pang, senior economist for Greater China at Natixis Asia Ltd. in Hong Kong.

The PBOC's easing cycle since late 2014 included a series of cuts that pushed the main interest rate to a record low. That's been accompanied by a buildup in borrowing that's increased debt to 264 percent of GDP, according to Bloomberg Intelligence.

While balancing between economic growth and cutting leverage has been an eternal game for policy makers, the latest moves show more willingness to sacrifice growth to control risks, said Tommy Xie, an economist at OCBC Bank in Singapore. “Reining in risks is the priority.”

Copyright 2018 Bloomberg. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.