Adds market movements and traders' comments
SHANGHAI, Aug 29 (Reuters) - China's government bonds rallied on Thursday after the country's banking regulator moved to restrict lenders' investment in policy bank bonds, widely seen as an effort to prod lending to the broader economy.
Bonds issued by Chinese policy banks, previously exempt from supervision, have now been brought under regulators' management on interbank investment, three sources told Reuters earlier in the day.
The move would force some banks to reduce their investment in policy bank bonds, the sources said, meaning more funds will now be freed up to lend across the broader economy.
The development, seen by traders as positive for government bonds, livened up afternoon trading in the interbank market with Chinese 10-year treasury futures rising sharply.
"The move could affect commercial banks' allocation and affect their demand for the bonds," said a trader at a Chinese bank, adding that investors could offload their holdings of policy bank bonds and invest in sovereign bonds.
The government bond futures for December delivery CFTZ9, the most-traded contract, gained as much as 0.51 percent to 99.425 in afternoon deals.
A second trader at a Chinese bank said the yield gap between government bonds and paper issued by China Development Bank, one of China's three policy banks, widened during the session. She expects the banking regulator's move will likely continue to underpin demand for government debt.
The trader said banks could boost lending to businesses, but added it may not be significant in the near term.
Yields on China's 10-year treasury bonds CN10YT=RR fell about 3 basis points to 3.025%, while those on the China Development Bank-bond for the same tenor was up about 2.5 basis points to 3.44%, according to traders.
The 10-year treasury futures finished the trading session up 0.32%.
The China Banking and Insurance Regulatory Commission was not immediately available for comment.
(Reporting by Hongwei Li, Steven Bian and John Ruwitch; Writing by Samuel Shen Editing by Shri Navaratnam)