ExclusiveHong Kong’s currency to remain pegged to the US dollar in the near future, IMF’s Lagarde says

Hong Kong’s currency should remain pegged to the US dollar, said the International Monetary Fund’s Managing Director Christine Lagarde, even if it has weakened to the lowest level in 35 years, barely 0.01 cent from touching a red line that triggers an intervention by the city’s monetary authority.

“The pegging mechanism in place is consistent with the fundamentals of the economy,” Lagarde said in an interview with the South China Morning Post, after delivering a speech at the Hong Kong University. “We certainly don’t see in the near future the pegging of the Hong Kong dollar to another currency, other than the US dollar.”

Lagarde’s comment comes as the city’s currency deteriorated to 7.8499 per US dollar on Wednesday, the weakest since the two currencies were pegged at 7.8000 in 1983. Under a trading band created in 2005, the Hong Kong Monetary Authority is compelled to step in to buy the local currency to prop it up once it reaches 7.8500 per dollar, or to do the converse if the city’s currency strengthens to 7.7500 per dollar.

For more than a year, traders had been actively selling Hong Kong dollars and buying the US currency in an arbitrage called the carry trade, which sells a low-yielding asset to buy another with higher returns, as they took advantage of the price difference between their borrowing costs.

The local monetary authority raises the city’s key interest rate in lockstep with the US Federal Reserve to maintain the peg’s value. However, the gap between the local cost of borrowing capital, known as the Hong Kong interbank offered rate (Hibor), and US rate is at its widest in months, fuelling the arbitrage.

“Liquidity is still flushed in the banking system because of all the money flowing into Hong Kong stocks and property. Hibor rates are likely to rise only at a very slow pace at in the first half of the year,” said OCBC-Wing Hang Bank’s economist Carie Li. “I expect the Hong Kong dollar to touch the lower limit of its trading band, activating the monetary authority’s operations only for a few times in short periods, rather than any prolonged intervention.”