Hong Kong’s peg needs shoring up by the billions

The Hong Kong Monetary Authority (HKMA), the city’s de-facto central bank, stepped in two times in a single week to defend the Hong Kong dollar after it fell to the lower limits of its trading band with the U.S. dollar.

The Hong Kong dollar have been pegged to the U.S. dollar since 2005 and is allowed to trade within a band of between HK$7.75-HK$7.85. Whenever the HK dollar slips to either edge of the band, the HKMA is required to intervene.

On Wednesday, the HKMA bought HK$3.925 billion to support the local currency against the greenback as it traded at 7.8498 per U.S. dollar. The move came four days after the HKMA spent HK$1.507 billion to do the same, the first intervention since August last year, when the Hong Kong dollar hovered near the 7.85 lower limits against the greenback.

Hong Kong’s aggregate balance of banking liquidity dropped to US$70.9 billion as a result of the intervention.

But the Hong Kong dollar still slid 0.01 percent to 7.8489 against the greenback on Friday, after two interventions made in a week.

Please mind the gap

“The major reason…is the significant widening of the interest rate gaps between the HKD and USD after the year-end, mainly because of the drop in banks’ funding demand, which led to a fall in HKD interbank interest rates. The wide interest rate gaps attracted carry trade activities that sell HKD for USD, pushing the HKD towards the weak side as a result,” Mr Howard Lee, Deputy Chief Executive of the HKMA, explained on March 9.

“Due to abundant liquidity in the HKD market, weak demand for loans and a lack of large scale Initial Public Offerings (IPOs), coupled with the Fed raising the interest rates in September and December last year by a total of 50 basis points, which further pushed up the USD interest rates, the interest rate gaps between the HKD and USD continued to be wide,” he added.

The Hong Kong Interbank Offered Rate (HIBOR) continued to rise, with the one-month HIBOR edging up to 1.55214 as of Friday morning, the highest since January 8.

No stemming the flow

A report from Daiwa Capital Markets Hong Kong said that unless the Fed cuts interest rates, capital will continue to flow out of Hong Kong.

“The pressures will continue for money to flow out from the Hong Kong dollar, as long as the rate spread exists,” Mr Kevin Lai, an economist at Daiwa Capital Markets Hong Kong, told Bloomberg.

Citibank Global Consumer Banking’s head of retail bank Ms Josephine Lee said the U.S. may have two interest rate hikes later this year if its economy recovers in the second quarter with upward inflation pressure.

Ronald Man, strategist at Bank of America Merrill Lynch, predicts that the HKMA  could spend another HK$60 billion this year to defend the currency peg, and that stock investors may sell Hong Kong dollars in exchange for yuan and buy mainland shares.

Last year, the HKMA defended the local currency a few times. It bought HK$70.35 billion in Hong Kong dollars in April and May, then HK$1.77 billion in August when the Hong Kong dollar hit the end of the trading band at 7.85.

It was the first time that the de-facto central bank had to take action to keep the Hong Kong dollar within the trading band since 2005.