Photo taken on June 22, 2016 shows a view of the Victoria Bay in Hong Kong, south China. (QIN QING / XINHUA)
Hong Kong should have the financial arsenal to defend the currency peg, but interest rate hikes associated with Hong Kong Monetary Authority’s recent currency interventions may exert pressure on the city’s real economy and property market, financial analysts reckoned.
We believe the HKMA has the ability and willingness to maintain the peg given ample official reserves. Hong Kong’s official reserves, currently at around $466 billion, is 5.8 times Hong Kong’s currency in circulation and 1.7 times its monetary base.
Sim Moh Siong,
currency strategist at Bank of Singapore
Since the United States Federal Reserve kicked off interest rate hikes to contain soaring inflation this year, the widening HK dollar-US dollar yield spreads keep the spot Hong Kong dollar exchange rate on the weak-side convertibility guarantee level of 7.85, forcing the HKMA to passively buy Hong Kong dollars from the market.
To defend the Hong Kong dollar, the HKMA has bought nearly HK$44 billion ($5.64 billion) in the last two weeks to stop the local currency from further weakening and breaking its peg to the US dollar. As of Wednesday, the aggregate balance — the key gauge of cash in the city’s banking system — had fallen to HK$191.31 billion following the currency intervention.
Economists and currency strategists are confident that Hong Kong can maintain the currency peg amid the predicted trend in US interest rate increases.
“We believe the HKMA has the ability and willingness to maintain the peg given ample official reserves. Hong Kong’s official reserves, currently at around $466 billion, is 5.8 times Hong Kong’s currency in circulation and 1.7 times its monetary base.
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This, along with potential assistance from the People’s Bank of China in very extreme situations, suggests that the HK dollar peg will likely remain highly credible,” predicted Sim Moh Siong, currency strategist at Bank of Singapore, the private banking arm of OCBC Bank.
“Hong Kong’s sound fundamentals in terms of its massive external surpluses, its stable banking system and low inflation are also not conducive to a currency crisis,” Sim added.
French-based international banking group BNP Paribas cites the strong external balance sheets, a liquid and well-capitalized banking system, and manageable financial market and household risks, as the three main fundamentals to support the HKMA in defending the peg.
“The Hong Kong dollar's peg to the US dollar has survived various currency crises since the LERS (Linked Exchange Rate System) was introduced in October 1983. Episodes include the European Exchange Rate Mechanism turmoil in 1992, the Asian financial crisis in 1997-98, the abandonment of Argentine currency-board system in 2002, and the one-off yuan revaluation in 2015. The peg has proven resilient again during the COVID-19 crisis, and may not be shattered even if US-China tensions step up, we believe,” Bloomberg Intelligence’s chief Asia FX and rates strategist Stephen Chiu noted.
As part of the automatic adjustment process under the linked exchange rate system, when the widening HK dollar-US dollar yield spread (due to US interest rate hikes) triggers the Hong Kong dollar to reach the weak-side convertibility level, the HKMA will sell US dollars and buy HK dollars, drawing down excess interbank HK dollar liquidity.
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But economists also argue that, while the HK dollar peg will not break, defending it will lead to higher interest rates in Hong Kong, which will not be helpful at a time when the economy is still struggling and easy monetary policy is needed.
“We expect the currency pair to stay close to the 7.85 mark for coming months, and more intervention will come along as well,” said Tommy Xie, an economist at OCBC Wing Hang Bank, the Hong Kong subsidiary of the Singaporean lender OCBC Bank.
“For the rest of 2022, we expect the Hong Kong dollar rates to be on a solid upward trend as hawkishness is seen everywhere. Yet, its upward move in the near term may still not be big enough to reverse the depreciating pressure on Hong Kong dollar,” Xie added.
“We believe that may accelerate the rise in the HIBOR (Hong Kong Bank Interbank Offered Rate), the benchmark rate to determine borrowing rates of mortgage loans in the city. The mortgage burden will increase, so we are monitoring whether this may eventually add pressure to the physical property market,” cautioned Magdelene Teo, Asia head of Fixed Income Research at Julius Baer, a Swiss private banking group.
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