Hong Kong’s Monetary Authority Raises Interest Rates in Lockstep with Fed to 16 Year High

The Hong Kong Monetary Authority (HKMA), Hong Kong’s de-facto central bank, raised its base interest rate charged through its overnight discount window unchanged at 5.75 per cent, tracking action by the U.S. Federal Reserve. Last meeting it raised its benchmark interest rate for a tenth time, following the US Federal Reserve. The latest move kept borrowing costs in the city to the highest level since January 2008. Hong Kong raises rates in line with the Fed due to the Hong Kong Dollar’s peg to the US Dollar. Immediately after the announcement the Hong Kong dollar strengthened to 7.7951 per dollar, its strongest level in eight months.

Hong Kong Dollar

“Under the linked exchange rate system, Hong Kong interbank offer rates will track the U.S. rates closely so that the spread between the two gradually narrows,” HKMA acting chief executive Arthur Yuen told a media briefing.

Defending the Peg

The HKMA move came after rounds of intervention by the HKMA to defend the Hong Kong dollar bumping into the weakest end of the peg at 7.85.

Persistent intervention by the HKMA had failed to put a floor under the Hong Kong dollar and interbank rates, as investment inflows from mainland China and a weak domestic economy have sapped loan demand.

Hong Kong’s aggregate balance, a gauge of liquidity levels in the banking system, has declined rapidly over the past year, and is down more than 90% from its peak in 2021. It fell to just 44.76 billion Hong Kong dollars ($5.7 billion) by Monday ahead of last months meeting, the lowest level since November 2008.

Since last May, the currency has touched 7.85, the weak end of the band over 40 times, prompting the HKMA to buy nearly 289 billion Hong Kong dollars ($37 billion) from banks to shore up its value, according to statistics released by the authority early last month.

The slump started in early 2021, when there was a decline in the flow of investments from mainland China into Hong Kong stocks as Beijing cracked down on the country’s internet giants and education companies, many of which are listed in the city. In the last 18 months, US interest rates have been the main driver for the pressure on Hong Kong’s currency.

John Greenwood who is credited as the chief architect of Hong Kong’s dollar peg after an article he wrote in 1983 provided the basis for the system, said ditching the peg would hurt the city’s role as an international financial center.

“A large proportion of Asia’s trade and capital transactions are still denominated in US dollars,” he told CNN. “Pegging the Hong Kong dollar to the US dollar encourages such transactions to be carried out in Hong Kong and under Hong Kong law, even if neither party is based in Hong Kong.”

On converting to the Yuan he said; “Hong Kong would not be able to operate a system that was fully and freely convertible to the mainland [currency] without undermining some of China’s financial controls,” Greenwood said.

Hong Kong is already struggling after Beijing’s crackdown on technology and private education firms back in July, and then the debt crisis at mainland Chinese developer China Evergrande Group. In an already precarious situation with the Chinese property market implosion higher rates have helped drive Hong Kong’s property market into a rare downturn, prices of residential properties and rent for office space also collapsed.

While Hong Kong’s official base rate follows the Fed’s policy rate, banks are not obliged to remain in lock-step with U.S. rates, especially when they see ample liquidity cushion in the system.

Hong Kong’s biggest banks such as HSBC Holdings Plc and Standard Chartered Plc are expected to keep prime rates unchanged with the HKMA move.

A seasonal factor that has led Hong Kong interbank offered rates higher in recent months is companies’ demand for the local currency for dividend payments, Yuen said, which traditionally peaks from June to August.

This has led the one-month Hong Kong interbank rate, the benchmark that banks use to price their residential mortgage loans, to surge to a 16-year high of 5.21% earlier this month, as it caught up and exceeded the one-month U.S. secured overnight financing rate (SOFR) before trending lower this week.

The end of dividend flows from Hong Kong-listed Chinese companies after August will help loosen Hong Kong dollar liquidity conditions, he added.

The Fed’s aggressive monetary tightening this year has raised concerns about Hong Kong’s linked exchange rate system, including its sustainability and relevance. Just last month, American investor Bill Ackman who founded hedge fund Pershing Square Capital Management, said that the mechanism no longer made sense for the city. He placed a monstrous bet for it to fail shorting the Hong Kong dollar.

The Hong Kong Monetary Authority however has said that it does not need or intend to change the system, citing strong buffers and deep liquidity in the banking system.

Source: HKMA

From The TradersCommunity Research Desk