The estimated range for settlement balances will evolve over time
Once we resume purchasing assets to offset the growth of currency in circulation, we will aim to manage our balance sheet in a way that keeps settlement balances in the range of $50 billion to $70 billion. But there may be brief periods when the amount falls below or rises above this range.
I also want to stress that, over the long term, demand for settlement balances will continue to evolve as the financial system evolves. So the amount that the major banks and other Lynx participants want to hold will likely vary as well. This means we will probably adjust our estimated range from time to time, possibly both up and down, to reflect changes in settlement balance demand. This way, we can make sure that our framework for implementing monetary policy remains effective at keeping the overnight rate in markets close to our target for the policy rate.
While our core objective is to supply enough settlement balances in the financial system for us to be able to implement our monetary policy effectively, that’s not our only consideration. Another important factor is market discipline, given that we are also responsible for promoting a stable and efficient financial system.
What do I mean by this? Well, we don’t want to see major banks and other core financial institutions under-investing in their capacity to robustly manage their liquidity because they have developed an unhealthy over-reliance on settlement balances. In managing their liquidity needs, financial market participants should be able to respond to fluctuations in those needs in other ways—for example, through access to markets.
Going forward, our assessment of the optimal range of settlement balances will account for the evolving nature of both payments and the financial system, as well as the need to maintain market discipline.
The return to business-as-usual balance sheet management
Okay, so what will business-as-usual look like after QT ends?
Under our normal course of balance sheet management, we buy assets on a passive basis to reflect the autonomous rise in our liabilities. Traditionally, the biggest liability has been currency in circulation. Demand for cash usually grows at roughly the same speed as the nominal growth of the economy.
I want to be clear, though, that while QT is almost finished, the composition of our asset holdings won’t be back to normal for quite some time. As I explained in my speech last March, we want to restore a more balanced mix of assets with a broader range of maturities—including more short-term assets—than we hold now. Currently, our asset portfolio is made up almost entirely of GoC bonds. And as a result, our asset holdings have a maturity profile that skews longer than it did before the pandemic. Going forward, we will hold not only GoC bonds but also GoC treasury bills (t-bills) and term repos, just as we did before the pandemic.
In steady state, we will aim to have the amount of our floating-rate assets, mostly term repos and t-bills, match the amount of our floating-rate liabilities, which include settlement balances. And we will aim to have the size of our bond holdings roughly match currency in circulation, given that currency is assumed to be a permanent liability. Although our asset purchase plan will be designed to ramp up to this steady-state composition, our asset growth is limited by how quickly currency in circulation grows. So we may not reach that composition until around 2030.
I want to emphasize that we will not be buying assets on an active basis to stimulate the economy like we did during the pandemic when we were doing QE. Our normal asset purchases before the pandemic were not QE. And our normal asset purchases after QT ends will not be QE either.
Now let’s get into some of the specifics of our purchasing plans.
When we start growing our assets again for business-as-usual balance sheet management, we will start with term repo operations. These will be 1- and 3-month terms, and we will gradually ramp up the amounts through bi-weekly operations.
T-bill purchases will take place in the primary market. We expect them to resume in the fourth quarter of this year, initially with relatively small amounts through each bi-weekly GoC debt auction.
GoC bond purchases will likely not start until toward the end of 2026—at the earliest. But, as we get closer to purchasing bonds, we will announce the timing well in advance.
When we start buying GoC bonds again in the normal course of business, we will do so in the secondary market, via reverse auctions. Secondary market purchases align with benchmark practices at other major central banks that buy their home jurisdiction’s government bonds as part of their normal-course balance sheet management. And there are advantages to doing it this way compared with buying bonds in the primary market—that is, at GoC auctions—which was our practice before the pandemic.
One advantage is that secondary market purchases will give us the flexibility to buy any GoC bonds outstanding across the full spectrum of maturities, rather than being limited to what’s on offer at individual GoC bond auctions. This will allow us to replace maturing bonds with bonds from the maturity buckets that we want, which will help us rebalance the maturity structure of our balance sheet more quickly.
Buying in the secondary market also helps enhance the GoC bond market’s functioning and liquidity. It gives participants more regular opportunities to trade and see pricing points for off-the-run securities that are less liquid than on-the-run bonds.
When we do become a regular buyer in these markets again, a couple of key principles will guide us to help ensure that our presence leans toward enhancing market functioning. First and foremost, we want to limit the market impact of our purchase operations. Our bond purchase operations, for example, will be price-sensitive, and we won’t necessarily buy everything that dealers offer to us. And second, we will always aim to be as transparent and predictable as possible. For example, we will publish calls for tender ahead of our operations, as well as quarterly purchase schedules.
So now you know what comes next once we’ve finished QT.
Where do recent repo market pressures fit?
Before I conclude, let me also take this opportunity to say a few words about the recent pressures in repo markets and how they fit into all this.
I want to be clear that we will not be ending QT out of any concern about the functioning of repo markets. Our assessment is that, for the most part, other factors are causing these pressures. I also want to be very clear that the pressures in repo markets are not a reflection or indication of broader financial system stress.
Last year, our analysis determined that upward pressure in repo markets was being caused primarily by positioning in bond and futures markets, largely by hedge funds. Through our more recent monitoring and discussions, we can see that hedge fund activity and positioning continue to contribute to higher funding requirements sourced in the repo market. These have led to upward pressure on repo market rates—along with other factors, such as the transition to a one-day settlement period for trades, also known as T+1 settlement.
We’ve also seen greater upward pressure on rates in overnight repo markets around regulatory reporting dates, such as at year-end or quarter-end for banks. This happens in many other major jurisdictions as well. Repo trading increases the size of a bank’s balance sheet and, in turn, its regulatory capital requirements. So as reporting dates approach, banks try to reduce their balance sheet to satisfy regulatory requirements. This tends to make them less willing to conduct repo transactions with clients and cash desks, due to the impact that repo deals have on their books. And that reluctance reduces the supply of repo funding to the market and can cause or amplify upward pressures on repo rates.
Our analysis also finds that the Bank’s routine overnight repo operations, where we inject funds into the market to ease upward pressure on overnight repo rates, can at times be less effective in these periods. This is because sourcing liquidity around reporting dates in the inter-dealer broker (IDB) market can be a better deal for banks and other intermediaries than getting it through our repo operations. Repo trading via IDBs offers netting benefits provided by central clearing, which lowers the amount of equity capital required for trades done in the IDB segment of the repo market. That is especially useful for intermediaries around reporting periods.
As always, we will continue to monitor all of these repo market dynamics.
Conclusion
It’s time to wrap up.
It’s been a long road—almost three years since we began QT—but we are just about finished the QT process and the unwinding of our QE-related asset holdings. We will announce the end of QT in the first half of this year, and we will re-start business-as-usual asset purchases after it ends.
When QT is done, we’ll go back to managing the balance sheet in a way that looks a lot like how we managed it before the pandemic. Crucially, when we start buying assets, these will be normal, passive purchases, reflecting the growth in currency—not QE.
However, because payments and the broader financial system have evolved, our approach to balance sheet management has also evolved. This is reflected in our shift to a floor system for implementing our monetary policy, which means we need to supply an amount of settlement balances that roughly matches the demand for them. And that demand is now estimated to be higher than where we thought it would be when I spoke about our QT process last year.
Over the longer term, since the financial system will continue to evolve, demand for settlement balances can be expected to evolve too.
Market participants can count on us to communicate our next steps clearly and ahead of time. And all Canadians can count on us to manage our balance sheet in a way that both lets us achieve our monetary policy mandate and promotes a stable and efficient financial system. Thank you.
I would like to thank Kaetlynd McRae for her help in preparing this speech.
