Capital flight of $7b prompts intervention by monetary authorities in support of the currency peg Hong Kong interest rates spiked sharply higher yesterday, after investors drained more than HK$7 billion out of the interbank money market to buy higher-yielding US dollars. The capital flight prompted the Hong Kong Monetary Authority to step into overnight trade in offshore markets late on Wednesday, and again before the local market opened yesterday, to buy HK$7.33 billion and support the local currency peg at 7.80 to US dollar. 'The [monetary] authority was obliged to provide US dollars to institutions and individuals who wished to switch out of the local currency,' said Bert Gochet, investment strategist for UBS Investment Research. 'Most of the outflows are probably institutional investors taking their money out of the equity market and repatriating it. Some might also be retail investors, who find Hong Kong dollar rates quite low now that the Fed is on a rising rate pattern.' Tightening liquidity and higher interbank rates will add pressure on local banks to raise both deposit and lending rates if the US Federal Reserve raises its target funds rate by another 25 basis points on August 10. 'The outflow of Hong Kong dollars means we need a more stable situation,' Liu Chong Hing Bank senior manager Brian Cheung said. 'Banks are swapping into US dollars to enjoy a 1 per cent difference in rates - so I expect local deposit and lending rates to rise.' The Hang Seng Index fell 137.16 points or 1.11 per cent to 12,183.10, partly in response to the prospect of higher borrowing costs for local lenders, with the August futures signalling a further retreat for the market. On the interbank money market, the benchmark three-month Hong Kong Interbank Offered Rate ended the day sharply higher, closing at 0.79 per cent from 0.49 per cent on Wednesday. With the strong capital inflows of the final quarter of last year now in full reverse, the large pool of Hong Kong dollars that built up in the system - the 'aggregate balance' - has been cut to HK$11.24 billion from a record high of $59 billion posted in November. Under normal circumstances the balance, which consists of bank funds held in clearing accounts with the HKMA, ranges between $500 million and $1 billion. Anticipating an increase in rates, Bank of China and Standard Chartered Bank have launched promotional campaigns aimed at attracting new customers with higher deposit rates. Officials at the Bank of East Asia and Wing Hang Bank said yesterday they had no plans 'at present' to respond to increased deposit rates announced earlier in the week by Bank of China or rising rates on the local interbank market. Liu Chong Hing's Mr Cheung said: 'If the Federal Reserve raises its rate by another 25 basis points, there is a 95 per cent chance that most Hong Kong banks will follow, because they skipped the first increase.' Citic Ka Wah Bank spokeswoman Betty Chan said the bank had no intention of making adjustments to its rates as a result of the Bank of China move. 'If US rates are raised a further 25 basis points on August 10, we will have to see how the market reacts before making any decisions on our rates,' she said. Analyst Alvin Chon of Sun Hung Kai Securities said an increase in lending rates would help smaller banks, which had so far absorbed higher funding rates without a rise in their lending rates. Although this would mean a rise in mortgage payments, he said he remained positive on the property market since household incomes were likely to rise with prices. Calculations by the South China Morning Post earlier this week showed that if prime lending rates were to rise 300 basis points to 8 per cent, repayments on mortgages raised to finance a HK$2.5 million property purchase would increase in a range of $2,400 a month to $3,800 a month depending on the loan-to-valuation ratio.