The Bank of Canada is coming under mounting pressure to accelerate the timeline to end its quantitative tightening program, even as it stays quiet on its plans.

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Central bank officials led by governor Tiff Macklem held their key interest rate at five per cent this week, acknowledging that they’re probably done hiking. But policymakers gave no substantive updates about their ongoing efforts to shrink the bank’s balance sheet — despite liquidity issues that prompted them to intervene in the repo market at the beginning of this month.

The Bank of Canada, like other central banks, bought huge quantities of bonds during the COVID pandemic, first to stabilize financial markets and then to suppress borrowing costs and help the economy. Its balance sheet grew to more than $570 billion.

It has since declined to around $317 billion as those bonds mature. That process, called quantitative tightening, helps drain cash from the financial system, removing stimulus from the economy.

Last year, the central bank said its expects to wind down its QT program by late 2024 or early 2025. But there’s some evidence it may need to move up that date.

The Canadian overnight repo rate average, or CORRA, has been stuck around five basis points above the Bank of Canada’s overnight-rate target for much of January, spurring the central bank to intervene with a series of repo operations.

CORRA measures the cost of overnight money using Canadian government treasury bills and bonds as collateral for repurchase transactions. It’s supposed to closely track the central bank’s target for the overnight rate. When it doesn’t, it can be a signal that short-term funding markets aren’t functioning as smoothly as they should.

“We were very surprised to not hear Macklem address the strains in repo markets and the potential implications for QT,” Taylor Schleich, a rates strategist with National Bank of Canada, said by email after Macklem’s press conference on Wednesday. “At the end of the day, they’re targeting the overnight rate and they’ve been missing their target for a number of months.”

During the bank’s first foray into quantitative easing during the pandemic, it bought government bonds that were funded in part by the creation of settlement balances — interest-bearing deposits used as a means of payment in Canada’s high-value payment system, called Lynx.

As those bonds have matured and disappeared from the asset side of the Bank of Canada’s balance sheet, the central bank has made corresponding decreases in its settlement-balance liabilities. That’s effectively reduced liquidity in financial markets as it withdraws a form of money from the system. Settlement balances have now shrunk to around $114 billion.

As liquidity declines, rising demands for cash can push CORRA higher than the central bank’s overnight rate, as lenders demand more compensation to part with their funds.

The gap between CORRA and the overnight rate suggests settlement balances may already be growing too scarce, and that policymakers may need to stop removing them. The Bank of Canada would do that by resuming bond purchases to stabilize the size of its balance sheet and ensure payments clear at a rate closer to the target of the overnight rate.

The bank had previously estimated that the normal level for settlement balances may be in the $20 billion to $60 billion range.

In a news conference after Wednesday’s rate decision, Macklem told reporters the central bank’s balance sheet is still “some ways” from what it considers normal, a time when it can end the QT program.

Some analysts applauded Macklem’s vague answer. “The lack of communication around QT plans is largely consistent with the need to keep monetary policy and policy operations separate,” Ian Pollick, who runs fixed income, currency and commodities strategy at Canadian Imperial Bank of Commerce, said by email.

When it comes to CORRA, “what we are seeing in funding is slippage, not stress. That means less urgency to actively chuck QT out the door just yet,” Pollick added. The central bank will probably telegraph its intentions around the April rate meeting, he said.

Macklem told reporters on Wednesday that the market will get ample notice of any plans to alter the path of quantitative tightening. “As we’ve done every time we’ve changed policy with respect to our balance sheet, we will get out ahead of that and indicate how we would likely do that. We’re certainly not there yet.”

— With assistance from Simon Kennedy.

Bloomberg.com