TORONTO, Jan 28 (Reuters) - The unprecedented liquidity injected into the financial system from the Bank of Canada's bond purchases has pushed some money market rates below the central bank's targeted interest rate, and analysts say the pressure will persist until the quantitative easing (QE) program is scaled back.
Below-target money market rates could impede the BoC's ability to deliver a so-called micro rate cut of less than 25 basis points without risking some rates turning negative, according to analysts. The BoC has indicated it could cut its already record low benchmark rate of 0.25% but keep it in positive territory if the economy weakens.
"QE was so large that it created so much cash, that it's sitting in the system," said Ian Pollick, global head, FICC strategy at CIBC Capital Markets. "That is putting a lot of downward pressure on very short-term interest rates."
He expects the Canadian central bank to taper its QE purchases in April when it releases its next monetary policy report.
CORRA, a measure of the cost of collateralized overnight lending between banks in Canada, tumbled to as low as 0.13% last week, having set below 0.25% since October, while Canada's 3-month treasury bill yield has touched a record low of 0.05%. Reduced supply has also weighed on T-bill yields.
Settlement balances with financial institutions, or reserves, that the BoC creates to pay for bond purchases have jumped to about C$350 billion ($272 billion) from less than C$1 billion last March when the central bank's first QE program was announced to support the economy during the COVID-19 crisis.
'INCREMENTAL STEP'
The excess cash weighing on money market rates could squeeze the returns of asset managers and some other financial institutions that lack access to the central bank's deposit rate and park their excess funds in money markets.
The BoC moved last Friday to relieve some of the downward pressure on money market rates by raising the maximum bidding amount and bid rate in its securities repo operations.
Last week, a central bank spokesman told Reuters that having market yields trade below the target for the overnight rate is consistent with behavior in other jurisdictions operating with a significant level of excess reserves, adding that adjustments to its operations could include expanding the range of eligible counterparties if necessary. The BoC said on Thursday it had nothing to add beyond what it said last week.
"It's an incremental step," said Andrew Kelvin, chief Canada strategist at TD Securities. It will put more collateral back in the system and drain some cash, but CORRA is still likely to set below target, he said.
The Federal Reserve and some other central banks running quantitative easing programs have also faced downward pressure on money market rates. But funding in Canada has been swelled by record levels of bank deposits after the federal government rolled out assistance programs in response to the crisis.
The BoC has been tweaking its bond purchases. In October, it reduced the weekly amount to C$4 billion from C$5 billion, shifting purchases towards longer-term bonds, and says it will further adjust its buying as confidence rises in the economic recovery.
But for now, the market has to live with the wall of cash.
"You have a market with a tremendous amount of excess liquidity and that excess liquidity is going to manifest itself in a lot of unintended ways," Pollick said. ($1 = 1.2853 Canadian dollars) (Reporting by Fergal Smith Editing by Denny Thomas and Paul Simao)
