The recent confidence seen in the local money market yesterday suffered a blow after traders uncovered a technical loophole in Hong Kong's currency board system. Short-term interbank rates surged amid anticipation the Hong Kong Monetary Authority would withdraw liquidity from the system. The overnight rate - which at one stage touched a day high of 5.5 per cent - finished at 5.25 per cent, higher than Monday's close of 5 per cent and the 4.5 per cent level maintained for most of last week. The one-month rate rose the most, by 162.5 basis points to 7.75 per cent. Traders said expectations of a possible withdrawal of liquidity began to circulate in the market during the morning session. Expectations ultimately turned to reality when the authority announced at 6 pm the aggregate balance at the Liquidity Adjustment Facility had been reduced by HK$800 million to HK$6.96 billion. As usual, the authority did not comment on the reduction, saying only that the Hong Kong dollar remained stable and it would monitor the situation. The belief stemmed from a similar experience on April 27, when China Telecom (Hong Kong), through an agent bank, tried to buy US$1 billion from the authority to help fund its US$2.9 billion purchase of an asset from its parent. Under Hong Kong's currency board system, when the deal was settled two trading days later on April 29, the system suffered a HK$7.7 billion outflow of funds, reducing the aggregate clearing balance to HK$7.3 billion from the previous HK$15 billion. A senior trader at a European Bank described the deal as a 'black-box operation' between the agent bank and the authority because it was not made public until the settlement day. So during the two-day period between execution and settlement, the agent bank would have been the only player in the market which could accurately expect there to be a dramatic reduction in the clearing balance. It could have made a huge profit from this anticipated movement by accumulating huge positions in forwards, he said. The trader said this deal had illustrated a very good profit opportunity for speculators.