Jake's View

HKMA prays for deliverance from loose money

With the HK dollar's currency peg under strain, the Hong Kong Monetary Authority must be hoping for an end to US quantitative easing

PUBLISHED : Tuesday, 08 January, 2013, 12:00am
UPDATED : Tuesday, 08 January, 2013, 7:45am

If they are not quite down on their knees at the Hong Kong Monetary Authority (HKMA), there is a least a silent prayer emanating from that tall office block with the set of roof claws from the movie Alien.

Dear God, runs that whisper, please let it be true that this year will see the promised end of Ben Bernanke's quantitative easing programme in the United States and please let interest rates start to go up now and please could we see a little strength in the US dollar, amen.

The Hong Kong dollar is hardly under attack at the moment, but the peg to the US dollar is under strain again, which is never a comfortable time for the HKMA.

First some history. It is not quite true that we have a peg at HK$7.80 to US$1, at least not for some years. As the first chart reveals, what we actually have is a convertibility undertaking.

It was adopted in 1998 at HK$7.75, which was the HKMA's way of saying that things had become a little ridiculous when an official HK$7.80 peg had rarely seen a spot exchange rate nearer that peg than HK$7.75 for six years.

The next move our monetary authorities made was to push the market rate slowly back to the official HK$7.80. There they stopped, rubbed their hands and said, "job done."

Except that it wasn't. What with a weakening US dollar, all sorts of capital inflows and an anomalous weakening of the interest rate mechanism that was intended to provide automatic regulation of the peg, the speculators began pushing things again.

Thus in May 2005 the HKMA adopted the system we have now. It will intervene in the market to prevent spot rates from going stronger than HK$7.75 or weaker than HK$7.85. As the first chart reveals, this intervention has in practice only been made to hold back HK dollar strength.

The second chart shows the lengths to which the HKMA has occasionally had to go to maintain this discipline. The red line at the bottom represents the US dollar reserves officially required to provide backing to the banknote issue. The blue line represents the full foreign reserves amassed to keep the peg in place.

Bear in mind that this is for monetary operations only and excludes our HK$1.5 trillion in fiscal savings. In the 2008-09 financial crisis alone, the HKMA had to soak up HK$700 billion worth of foreign currency to stop the exchange rate from going stronger than HK$7.75.

And as is evident from the right side of the second chart, these interventions have recently had to be geared up again at a pace last seen in 2009.

So here are the two questions. How deep are the HKMA's pockets, and how deeply does it want to reach into them?

The answer in both cases is very deep indeed. We are not at peg breakdown levels yet, far from them. But it does increasingly put us on one side of a big US dollar bet, and the low interest rates it brings contribute to the further heating up of an already overheated property market.

This is not a comfortable game for any central bank to play, and the HKMA can hardly welcome being forced into it. Listen closely and you'll hear that prayer.