The 0.5 percentage point reserve hike, announced during a special trading session on Sunday and effective from May 15, will lock up around 170 billion yuan ($22 billion).

But that amount is tiny compared to the more than 1 trillion yuan which was temporarily frozen in last week's equity offer by Bank of Communications and was released to the market on Monday. More money is set to flow back after the end of a long public holiday on May 1-7. "There is simply too much liquidity in the market," said money market analyst Yang Yongguang at Guohai Securities.

"Monday's downtrend in short-term rates trend is likely to last for another week after the holiday, until mid-May when April macroeconomic data are likely to cause jitters over an interest rate hike again."

The weighted average seven-day repo tumbled 25.06 basis points to 1.8107 percent by midday on Monday, reaching its lowest level since late March, when a period of heavy IPO activity began.

The rate is expected to drop further to around 1.5 percent right after the holiday, analysts said.

Improving liquidity helped the indicative one-year central bank bill yield in the secondary market ease 0.50 bp to 3.0025 percent bid, while the three-month yield was down 0.88 bp to 2.7100 percent, according to Reuters Reference Rates.

In the government bond market, the indicative five-year yield edged 0.11 bp higher to 3.1611 percent bid, but the 15-year yield fell 1.11 bps to 3.7311 percent.

Sunday's announcement reduced concern that the central bank might take a harsher monetary step, an interest rate hike, over the long holiday -- it is unlikely to make two major policy announcements in quick succession, traders said.

But many believe rate hike speculation could return in mid-May, when the central bank will see April consumer price inflation data. The market now appears to be forming a consensus that April inflation will be 3.1 or 3.2 percent.

That would be down from 3.3 percent in March, but higher than Beijing's target of 3.0 percent for 2007 -- and it would keep real interest rates negative, as the one-year benchmark deposit rate is now at 2.79 percent.

Such inflation could justify a rate hike as soon as in May, while also encouraging the central bank to step up money market operations to absorb excess liquidity, traders said.

Aggressive open market operations could bring the seven-day repo above 2.0 percent by the end of May from the 1.5 percent area which it is expected to reach right after the holiday, though much will depend on the IPO schedule, traders said.