Hong Kong defends currency peg amid outflow of capital chasing US dollar assets

hong kong defends currency peg amid outflow of capital chasing us dollar assets

The Hong Kong Monetary Authority is based in Hong Kong’s Two International Finance Centre. (South China Morning Post photo)

HONG KONG: The Hong Kong Monetary Authority (HKMA) on Wednesday intervened in the foreign-exchange market for the first time in seven weeks to defend the local currency's peg against the US dollar, following flight of capital from the Hong Kong dollar market after US rates rose to a 14-year high last week.

The HKMA, the city’s de facto central bank, bought HK$1.94 billion (US$247 million) and sold US$247 million, it said in a statement, to support the peg after the local currency hit the weaker end of its HK$7.75 to HK$7.85 trading band with the US dollar.

This marks the HKMA’s first intervention since Aug 9, and comes after capital outflows from Hong Kong within a week of the US Federal Reserve raising its funds target rate by 75 basis points to between 3 and 3.25% last Thursday. The Fed has raised rates five times over the past six months to tame runaway inflation that has hit a four-decade high.

“The aggressive US interest rate rises have led to capital flowing out of the Hong Kong dollar and into the US dollar for higher yield,” said Bruce Yam, an independent foreign-exchange analyst. “The HKMA has no choice – it will need to intervene more in the near future to continue buying the Hong Kong dollar to defend the peg.”

The local currency has been pegged to the US dollar at HK$7.80 since 1983. The HKMA is obliged to keep the local dollar trading within a trading band introduced in 2005 and has to intervene whenever the exchange rate veers out of this range.

The authority has had to intervene in the market 32 times this year, buying a total of HK$215.035 billion and selling US$27.39 billion amid persistent capital outflows. Its current intervention has surpassed in size measures taken to support the weak Hong Kong dollar during the last interest-rate rise cycle, when it bought HK$103.48 billion in 2018 and HK$22.13 billion in 2019.

The HKMA has also raised its base rate in lockstep with the Fed to a 14-year high of 3.5%. The city’s commercial banks have, however, waited out five rounds of rate increases this year before raising their own.

Ten major lenders – including the three note-issuing banks HSBC, Standard Chartered, and Bank of China (Hong Kong) – only increased their best lending rates last Friday or this week by 12.5 basis points, which is a much slower pace than the US. This has triggered the so-called carry trade where traders sell the Hong Kong dollar and buy US dollar assets.

The latest round of intervention will reduce the aggregate balance, the sum of balances in clearing accounts maintained by banks with the HKMA, to HK$123.336 billion, which is 64% lower than the HK$337.53 billion before the first intervention this year on May 11.

The Fed is expected to continue increasing interest rates in November and December, after US consumer prices surged by an annual rate of 8.3% in August, analysts said. This was slower than the preceding two months, but still hovered near a four-decade high.

The HKMA’s base rate now stands at 3.5%, its highest level since the financial crisis in March 2008.