(Bloomberg) -- UK banks borrowed a record amount of cash from the Bank of England’s weekly repo facility, part of an upward trend that analysts suggest is a sign of early liquidity strains in sterling money markets.
Financial institutions on Thursday tapped over £38 billion ($50 billion) from the central bank’s short-term repo facility, which provides cash in return for gilts pledged as collateral. That’s up from as little as £700 million at the start of the year.
BOE officials have repeatedly said the increased usage does not point to liquidity issues, and they are confident that reserves — the deposits commercial banks hold at the central bank — remain well above the minimum amount required before cash across the financial system becomes scarce.
Still, analysts at Citigroup Inc. and NatWest Markets argue that the heightened demand is a consequence of tighter liquidity in some pockets of the market, noting that financing needs are not evenly distributed across various banks.
The rising take-up is indicative of a monetary system that is closing in on the point at which reserves become scarce “slightly earlier than the BOE previously thought,” Imogen Bachra, head of economics and markets at NatWest, said Thursday.
The BOE next month will decide how fast to remove reserves from the banking system through its quantitative-tightening program. The central bank has been siphoning off liquidity by shrinking its balance sheet, and commercial lenders have turned to the BOE’s repo facility as an alternative source of funding.
Officials have welcomed the increased usage, with Governor Andrew Bailey saying it is necessary to reduce the risk banks cannot access funding when reserves drop too low. BOE reserves are currently above £700 billion, compared with a peak near £1 trillion in early 2022.
Arbitrage Opportunity
That’s still well above central bank’s estimate of the point that reserves become scarce, which it estimates is somewhere between £345 billion and £490 billion. That said, members of the BOE’s money markets committee warned in June that it may be higher than this range.
One reason for increased demand for short-term repos is that banks are opportunistically choosing to finance their gilt holdings at the BOE rather than in the repo market, and then roll over their funding. That chimes with the view of the BOE’s executive director for markets Vicky Saporta, who said last month that banks can use the facility to “arbitrage away” higher repo rates in the market.
NatWest’s Bachra said this explanation is “partly true” but “it’s not the only driver.” The Citi team, while acknowledging there is a positive relationship between short-term repo usage and repo market rates, also believe something else is going on.
The record demand makes it “more tempting to suspect that liquidity may not be that abundant in some corner of the sterling money market,” the Citi analysts Jamie Searle and Andrea Appeddu said Thursday.
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