Why do repo markets matter?
Repo markets are vital in facilitating the flow of cash and securities around the financial system.footnote [1] A repurchase agreement (repo) involves one party lending cash to another party, secured against some form of collateral. As well as a source of short-term funding, repos can also be used to source bond collateral for speculation and risk management activities.
This post focuses on gilt repo – sterling repo backed by UK government bonds – where the vast majority of transactions rely on dealer intermediation. The gilt repo market plays an important role in supporting the functioning of the gilt market, by facilitating short-term liquidity and collateral management. Central banks also use repo-like facilities to supply reserves (deposits held by commercial banks at the central bank) and ensure interest rate control.
How has the changing cash-collateral balance affected repo markets?
Globally, reserves have fallen and bond issuance has increased over the past few years, changing the cash-collateral balance in repo markets. In the UK, since February 2022, the stock of aggregate reserves has decreased by around £250 billion. Reserves have fallen globally as many advanced economies have engaged in quantitative tightening (QT), and in the UK the unwind of the Term Funding Scheme with additional incentives for Small and Medium-sized Enterprises (TFSME) has also contributed to the decline in reserves. During the same period, UK government bond free-float has increased by around £500 billion, through a combination of higher net issuance and QT sales. Money markets have therefore shifted from an environment of relatively plentiful reserves and collateral scarcity towards the present period of declining (though still abundant) reserves supply and more plentiful collateral (Chart 1).
Chart 1: Ratio of sterling reserves balances relative to gilt free-float (a)
Footnotes
- Sources: Bank of England data, UK Debt Management Office and Bank calculations.
- (a) The gilt free-float is calculated using gilt issuance history as the total amount of gilts outstanding in nominal terms (not including the index-linked uplift) less the Bank of England’s holdings of gilts – including both temporary holdings related to financial stability intervention and Asset Purchase Facility holdings.
As a result of the shifting cash-collateral balance in the system, there has been upward pressure in repo rates globally (Chart 2).
Footnotes
- Sources: Bank of England, Bloomberg L.P. Finance, European Central Bank (ECB), Federal Reserve, Sterling Money Market Data Collection and Bank calculations.
- (a) This chart looks at the spread between broad overnight general collateral repo rates and policy rates for each jurisdiction. For the UK, the repo rate is calculated using the Sterling Money Market Data Collection and the policy rate as Bank Rate. For the US, SOFR is used as a repo rate and IORB as the policy rate. Lastly, the repo rate for the euro areas (EA) is taken from a STOXX pooled index and the policy rate considers the ECB Deposit Facility Announcement Rate.
- (b) It excludes quarter-end reporting dates and any data points that display a spike attributed to a monetary policy decision (removed at best endeavour).
- (c) Each series computes a five-day rolling average.
For the UK, the Bank’s Sterling Money Market Dataset (SMMD) allows us to differentiate between gilt repo trades that are driven by the demand and supply of cash, where agents are indifferent around the specific collateral used (ie general collateral (GC) trades), and those that are collateral-driven, where specific collateral is pledged.footnote [2] In the current plentiful collateral environment, the spread of GC rates relative to Bank Rate (GC-BR spread) has settled at a positive spread to Bank Rate. This is above average rates observed in the post dash for cash and collateral scarcity regimes (Chart 3). In collateral-driven rates, the return to a more plentiful collateral environment has resulted in a reduction in the spread between secured borrowing rates on specific bonds and the GC rate (Chart 4). This ‘specialness’ was particularly acute for short-dated collateral bonds since the start of the tightening cycle.