SHANGHAI - China's money markets showed signs of increasing strain on Thursday, with rates jumping after the central bank drained money from the system for a second week, as uncertainties about forward-looking policy had market players hoarding cash.

The rise in rates stems more from worries about further liquidity tightening as opposed to an actual shortage of cash, traders said. Investors are still uncertain how aggressively the People's Bank of China (PBOC) is going to attack the excess cash that has aggravated inflation and pushed up property prices.

The communique issued at the closure of the Communist Party's third party plenum on Tuesday committing to market reform did not reassure investors, and equity markets sold off on Wednesday.

Traders and economists expect the PBOC will move to get a grip on inflation by manipulating short-term rates, instead of making long-term changes to the country's base money, which would risk crimping economic growth.

But most market participants are not clear how and when the strategy will be executed; whether the impact will be drastic or mild or if it will work at all.

"The market is quite nervous about how far the PBOC is willing to go to drain liquidity," said a dealer at a Chinese commercial bank in Shanghai, who spoke on condition of anonymity because he is not authorised to speak to the media.

"Even though many banks appear to still have an abundance of money on hand, there is a prevailing feeling of insecurity, so few are willing to lend aggressively."

Regulatory tweaks in the interbank market can have dramatic spillover effects. A tightening manoeuvre executed by the central bank in June saw short-term rates rise as high as 30 percent, causing a dramatic slide in domestic indexes and rattling overseas investors.

The PBOC abstained from open market operations on Thursday morning, resulting in a net drain of 15 billion yuan ($2.46 billion) from the interbank market.

Shortly afterward, an auction of three-month Finance Ministry deposits came in at 6 percent, up sharply from the previous auction of the same tenor of 4.23 percent and the highest yield in two years.

In addition, a three-year bond auction by the Agricultural Development Bank of China on Tuesday failed to sell out and priced more than 20 basis points above expectations.

The benchmark seven-day bond repurchase agreement opening quote was at 4.5 percent, leaping sharply from Wednesday's close of 3.74 percent, and ensuing quotes kept the volume-weighted average rate above 4 percent.

Domestic stock markets were down on Thursday morning, dragged down for a second day by financial stocks.

China's central bank faces a quandary as it tries to balance its desire to keep the yuan's exchange rate stable against concerns that intervention in the forex market is inadvertently pouring yuan-denominated liquidity into the short-term money markets.

The central bank has been recently guiding the yuan higher, and set a record high midpoint on Thursday morning. Forex traders expect it to continue to rise gradually in upcoming months.

Signs that the United States is set to continue its loose monetary policy under new Federal Reserve chief Janet Yellen have investors seeking higher-yielding currencies and assets, which by extension has encouraged capital inflows into China.

These inflows join other internal sources of seasonal cash, in particular tax revenues being deposited by the Ministry of Finance throughout the banking system that usually occur at the end of the year.