Excess liquidity signals Bank of Canada's bond purchases too big for money markets


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.