(Bloomberg) -- China’s central bank took the next step toward selling government bonds to cool a record-breaking rally, saying it now has “hundreds of billions” of yuan of the securities at its disposal through agreements with lenders.

After months of investor speculation about its intentions, the People’s Bank of China disclosed the clearest outline yet of its unprecedented plans in a statement to Bloomberg News on Friday.

It said it has hundreds of billions of yuan worth of medium- and long-term bonds at its disposal to borrow, after signing agreements with several major financial institutions. The central bank said it would borrow the bonds on an open-ended unsecured basis and sell them depending on market conditions.

The PBOC’s reply came after Bloomberg reported it had signed an agreement with Industrial & Commercial Bank of China Ltd. and was in talks with Postal Savings Bank of China Co. to borrow bonds, according to people familiar with the situation.

“Hundreds of billions are decent amounts when it comes to monetary operations,” said Frances Cheung, strategist at Oversea-Chinese Banking Corp. “The intention to sell mid-to-long end bonds is in line with our expectation, given the current bullishness in the bond market.”

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China’s sovereign bonds have surged this year on the back of the country’s gloomy economic outlook and expectations for interest rate cuts. The lack of attractive alternatives and a switch out of savings to financial investments has fanned demand and an increase in government borrowing to boost fiscal stimulus failed to put off buyers.

However, the PBOC has been pushing back against the rally, warning investors of the potential for losses should the market reverse. The central bank sees excessively low yields as endangering financial stability and weighing on the yuan.

Benchmark yields rebounded from a record low this week after the PBOC said it would borrow bonds from primary dealers, a sign it may be contemplating selling the securities to cool the market. 

“We think that hundreds of billions of amounts are likely to change the short-term momentum of the market,” said Yongbin Xu, co-chief investment officer of U-shine fund. “It is still difficult for PBOC’s action to change the long-term trend of bonds, the fundamentals plays a key role.”

The idea of the PBOC trading bonds as a potential tool came to the market’s attention via an old speech by President Xi Jinping, although such operations are also seen as a longer-term plan for better liquidity management in the financial system.

But a practical issue quickly became apparent that there may not be enough bonds for the PBOC to sell, or at least those with the maturities it wants to guide. Unlike peers such as the Federal Reserve or Reserve Bank of Australia which accumulated sizable amounts of debt before subsequently reducing their balance sheets, the PBOC has only bought a few batches of special sovereign bonds more than a decade ago.

Some speculated that the PBOC would look to borrow securities from primary dealers or big banks and sell them into the market, a move with little precedent in the global central bank playbook. The central bank held about 1.5 trillion yuan ($207 billion) of government debt on its balance sheet as of April.

Analysts expect that yields may now settle into a range as the fundamentals driving the demand linger. China’s 10-year yield edged up one basis point to just over 2.25% on Friday, up from an all-time low of 2.18% on Monday, according to data compiled by Bloomberg. 

“After a strong bull run year to date, CGB yields are entering a consolidation phase,” said Jenny Zeng, APAC fixed income CIO at Allianz Global Investors. “We believe there’s a limit on how much yields can actually rise from here, given China’s economic cycle.”

The results of a 30-year government bond auction on Friday suggested demand was broadly unchanged from the last sale in June albeit at a slightly higher yield. That was seen as an early test of how the PBOC’s new borrowing arrangement would impact investor appetite.

“We still expect the PBOC would prefer ten-year yields to rise back up to close to 2.5% at least,” said Stephen Chiu, chief Asian foreign-exchange strategist at Bloomberg Intelligence. “So 2.3%-2.4% could be an achievable range, especially given that demand will be intact.

PBOC Salvo on Bond Rally May Have Limited Impact, Analysts Say

Trading bonds is just one shift in how China’s central bank plans to operate in the midst of a decades-long reform of how it conducts monetary policy. Under proposals laid out by Governor Pan Gongsheng in a June speech, the PBOC is considering a switch to using just one key short-term policy rate. 

China watchers are also preparing for one of the country’s biggest annual policy meetings later this month, the so-called Third Plenum. Leaders at an economic meeting in December said they were contemplating a “new round of fiscal and tax reform,” sparking hopes that details may be unveiled there.

“The agreement opens the door for the PBoC to intervene in the market to stem off volatility,” said Gary Ng, senior economist at Natixis. “However, the current scale seems like it is more for a cyclical purpose as it will not be big enough to revert the market forces driven by economic rationale, such as the expectation of lower rates.”

--With assistance from Wenjin Lv, Shulun Huang and Qizi Sun.

(Updates with auction results and additional context)

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