Bank of Canada Monitors Overnight Funding Markets

by Warren Seah

Bank of Canada officials have announced their commitment to closely monitor activity in overnight funding markets. They clarified that measures to add temporary liquidity should not be misconstrued as a shift in rate policy or a sign of stress within the financial system.

Concerns have been raised by some market observers about the need for the Bank of Canada to scale back its plans on quantitative tightening, which commenced in April 2022 alongside its rate-rising campaign. The central bank aims to reduce its balance sheet, which had significantly expanded during the pandemic due to bond buying, by allowing its holdings of Canadian government bonds to mature without reinvesting the proceeds.

To address the situation, the central bank has recently injected liquidity into the markets through overnight-repo operations. This action was taken as the cost of overnight collateral funding remained above the Bank of Canada’s policy rate of 5%. Additionally, the Bank of Canada has announced the resumption of auctions for excess federal government cash balances, which were previously suspended in mid-2020.

While the Bank of Canada continues its balance sheet reduction efforts, it is also exploring other channels to ensure adequate liquidity. PGM Global, a Montreal-based securities trading firm, cautioned that this piecemeal approach could potentially lead to broader financial stress.

Bank of Canada’s Interest Rate Decision


The Bank of Canada’s interest-rate decision on January 24th was influenced by a surge in demand for government bonds. Traders believed that bond yields had already reached their peak in the previous fall, causing them to show strong interest in these assets. As a result, the overnight collateral rate experienced upward pressure. However, central banks’ intentions to cut rates this year led to a decline in yields, as they move inversely with prices.

Implementation of Monetary Policy

Senior officials at the Bank of Canada clarified that the need for overnight repo operations was primarily an operational issue related to implementing monetary policy. It was not a response to financial stability considerations or a change in the stance of monetary policy. The officials agreed to closely monitor overnight funding markets and utilize operational tools to maintain the overnight interest rate at approximately 5%.

Market Friction and Bond Holdings

Ian Pollick, the global head of fixed-income strategy at CIBC Capital Markets, reassured that there are no signs of stress in funding markets. However, he noted that there is some friction as the central bank decreases its bond holdings. He emphasized that the central bank is keen on ensuring the cleanliness and efficiency of the funding system.

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