C$ use as reserve currency seen trimming yields- Bank of Canada

OTTAWA Tue May 13, 2014 10:57am EDT

OTTAWA May 13 (Reuters) - The increased use of the Canadian dollar as a reserve currency may lower bond and money market yields but may also cut into market liquidity since central banks are less likely to trade, the Bank of Canada said in a report on Tuesday.

The report, entitled "The Canadian Dollar as a Reserve Currency," noted that central banks and monetary authorities had started adding Canadian-dollar assets to their official foreign reserves portfolios over the past five years.

"A clear reflection of Canada's relative economic resilience during the global financial crisis of 2007-09 is the growth in the share of foreign exchange reserves that other countries hold in Canadian-dollar securities, particularly those issued by the government of Canada," the central bank study said.

"The holdings of official foreign investors are likely to remain a salient, and may become an even more important, feature of Canadian government debt markets."

It estimated total reserve holdings of Canadian-dollar-denominated securities at around US$200 billion, and said that International Monetary Fund data showed that the Canadian dollar accounted for 1.8 percent of reported global foreign reserves in the third quarter of 2013.

The Canadian dollar started to attract increased interest from foreign reserves managers around 2009-10, it said, pointing to the central banks of Chile, the Czech Republic, Iceland, Macedonia and Russia as starting investing in Canadian assets.

It noted the Swiss National Bank's decision to bump up its target weight of Canadian-dollar holdings to 4 percent in 2010 from 2 percent previously.

Canada's share in global reserves may increase since emerging economies allocate a higher weight to the Canadian currency than advanced countries, 2.1 percent versus 1.6 percent, and most of the growth in reserves is expected to come from emerging economies, it said.

Increased use of the Canadian dollar can be expected to reduce the funding costs of the federal government, it said. However, the secondary market turnover of securities may decline, making it more difficult for investors to trade in Canadian markets, possibly translating eventually into higher yields. (Reporting by Randall Palmer; Editing by Chizu Nomiyama)

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