The yield on China's 10-year government bonds hit a 10-year low last Friday because of an ongoing increase in the price of government debt. What's behind the price rally?

The 10-year yield on China's sovereign bonds maturing in 2026 dropped to 2.635 percent last Friday, the lowest since 2006. The rate then rebounded today to some 2.6820 by 3 p.m.

Friday's fall in the yield meant an increase on the bond price, and experts say the rally was caused by foreign central banks and sovereign funds' desire to stock up on yuan bonds.

"Since the Renminbi joined the SDR basket on October 1st, overseas central banks and sovereign wealth funds have started to increase their holdings of China's domestic government debt," said Wan Zhao, senior analyst, China Merchants Bank.

"Foreign financial institutions usually have a targeted range of yields, so the ten-year period is an appropriate one for them to invest. The second reason is that a large amount of domestic capital is looking for safe-haven assets."

Wan says market liquidity is comparatively tight now, as can be seen from frequent actions by the People's Bank of China launching reverse repurchase agreements to inject liquidity into the money market.

Today, the central bank pumped 170 billion yuan into the market via reverse repos. One of the most important indicators for the money market, the overnight Shanghai Interbank Offered Rate jumped 0.9 basis points today to 2.231 percent. Friday's bond price rally points to expectations of lower interest rates and a gloomy outlook for China's economic growth.

However analysts say Beijing is not likely to cut rates further to encourage more lending, as the International Monetary Fund has already warned that China's overall debt ratio at 200 percent of GDP is not healthy. More debt would just add more stress to the financial system.

"The chances of an overall interest rate cut are not high. We are unlikely to see either an overall tightening or loosening in monetary policies," Wan said.

"A loose monetary policy would not help curb asset bubbles, such as the bubble in the property sector. At the same time, however, interest rate hikes would not help stabilize sluggish economic fundamentals."

China issued a total of 3 trillion yuan of bonds in September, 306.6 billion yuan of them in treasury bonds.