China's central bank bill and government bond yields edged lower on Wednesday as easing concerns over another monetary tightening step in the coming weeks along with ample liquidity kept sentiment cautiously optimistic, traders said.

Expectations were strengthened after the People's Bank of China signalled that it might keep official interest rates stable until early February by letting the auction yield of its one-year bills rise only moderately on Tuesday, traders said.

In its open market operations, the central bank also used 14-day bond repurchase agreements for the first time in three years to help drain liquidity, a sign that it might also refrain from raising bank reserve requirement ratios (RRR) ahead of the Lunar New Year, which falls on Feb. 3 this year.

Signs are that another imminent tightening is unlikely, although the PBOC often surprises as well, said a bond trader at a Chinese commercial bank in Shenzhen.

But the yields should have little potential to fall sharply in a monetary tightening cycle, with part of the market expecting an RRR or rate hike as early as early February.

The benchmark 10-year bond yield CN10YT=RR inched down 4 basis points to 3.85 percent at midday on Wednesday, while the 15-year yield CN15YT=RR lost 5 bps to 4.00 percent.

Traders said they expected bond yields to range trade in the run-up to the December data scheduled late next week.

Expectations of December consumer inflation remain at 4.3 to 4.5 percent, down from a 28-month high of 5.1 percent in November but only because of a high base in the same month of 2009.

In the money market, the benchmark weighted average seven-day government bond repurchase rate CN7DRP=CFXS added 3 bps on Wednesday but traders said the potential for it to rise sharply was limited because of an abundance of liquidity.

The repo rate rose to 2.4892 percent at midday from 2.4584 percent at Tuesday's close, with traders expecting it to move mainly in a range of 2.4 to 2.5 percent in coming sessions.

Money market rates have been in disarray after two surprise PBOC rate hikes and three RRR rises since October, jumping more than 400 bps from October to December on the uncertainty of PBOC tightening steps and then falling slightly less since then on banks' customary lending spree at the start of the year.

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