Hong Kong dollar near 17-month low ahead of Fed rate decision
Hong Kong’s dollar traded near its weakest level in 17 months, reflecting an increasingly nervous market ahead of the upcoming Federal Reserve policy meeting and expectations that the timing of a rate rise in the city may be brought forward.
The currency fell as low as 7.7985 per dollar on Tuesday, its weakest level since January 2016 and down from an intra-day level of 7.8004 on Monday. Under the linked exchange rate system, the Hong Kong Monetary Authority (HKMA), the city’s de facto central bank, is obliged to buy and sell US dollars to prevent the currency from breaching either side of a trading band between 7.75 and 7.85.
Markets are pricing in a 25 basis points increase in the US Fed Fund target rate to 1.25 per cent on Wednesday that would be the fourth rate rise since December 2015. The HKMA has increased its base rate three times since 2015, in lock step with the Fed to maintain the currency’s peg with the US dollar.
But Hong Kong’s dollar has weakened this year because commercial banks in the city have been keeping their prime rate at 5 per cent, reluctant to raise their bank rates. As the US dollar interest rate has climbed while the city’s bank rates remained low, the widening interest rate differential has led to selling of Hong Kong dollars.
The government has unveiled eight rounds of property tightening measures since 2014 but housing affordability remains one of the gravest issues facing the city.
Four major Hong Kong banks including Standard Chartered and HSBC raised their Hibor-linked mortgage rate in May but lenders still have little room to increase mortgage rates because of intense competition in the industry.
Consequently, the Hong Kong dollar is likely to remain under pressure, which may cause a clean break from the 7.80 level, according to Jasper Lo, chief strategist at King International Financial.
Historically, the HKMA would buy Hong Kong dollars when the currency fell to 7.83, rather than waiting for it reach the 7.85 lower limit of the trading band.
While there is no threat to the Hong Kong dollar peg arrangement for the forseeable future because foreign reserves stand at US$396 billion, such action by the HKMA would probably shrink those reserves as well as domestic money supply.
“Hong Kong commercial banks will need to raise mortgage rates this time after the Fed’s rate hike if they want to avoid greater pressure on the currency that would cause market volatility to spread,” Lo said.
Interbank rates soared in 1998, as foreign reserves fell and the domestic money supply shrank. The HKMA took some unorthodox steps, such as buying Hong Kong stocks as the Hang Seng index plunged.
A research note by strategist Ken Cheung at Mizuho Bank said Hong Kong’s local banks and regulators will be aware of capital outflow risk and will consider lifting rates earlier, before the local currency hits 7.85 level.
A surprisingly hawkish Fed at its policy meeting could push forward the timing of rate increase in Hong Kong and would probably trigger a deeper correction in local financial markets, Cheung said.