As the US Federal Reserve engineered the biggest interest rate increase in more than a quarter of a century to rein in runaway inflation, it faces accusations that it was asleep at the wheel. Whether the criticism is justified, Hong Kong will pay a price as borrowing costs jump and so-called hot money makes an exit. At a time when the local economy is reeling from the impact of the Covid-19 pandemic, the tough monetary tightening is unwelcome, but not unexpected. The world’s most powerful central bank on Wednesday raised its benchmark rate by 0.75 percentage points and warned another increase of a similar size was on the cards. It is showing determination to tame inflation. The question now is whether the tightening will induce a recession in the United States and elsewhere. Thanks to the currency peg, the Hong Kong Monetary Authority has immediately followed in lockstep by pushing up its base rate by the same amount, or 75 basis points, to 2 per cent. The city’s finance policy bosses have reassured the market that it has ample liquidity to address any short-term depreciation of the Hong Kong dollar. Hong Kong, after all, sits on a HK$4.6 trillion (US $586 billion) war chest with the Exchange Fund while the local banking system is fully liquid with HK$280 billion flowing around. The city’s financial system is well prepared, at least for now. Still, there are headwinds to come. The higher interest rate in the US will intensify the so-called carry trade, as traders sell a low-yielding product such as the Hong Kong dollar to buy a higher-yielding one, which is the US dollar. In this case, the price difference is calculated between the local borrowing cost known as the Hong Kong interbank offered rate (Hibor) and the US borrowing cost denominated as the Libor. This will add to the already volatile equities market and the Hong Kong dollar. Local mortgage holders whose home loans are pegged to Hibor will already feel the pain. Hong Kong stocks slip with Asian markets as Fed raises rate, recession risks Those with more traditional loan repayments may delay higher costs for now, as major commercial banks such as HSBC, Standard Chartered and Bank of China (HK) are holding their prime rates steady. During the last rate cycle, Hong Kong’s banks waited through eight increases before passing the pain to borrowers. There’s no guarantee they will wait that long this time, as the blows come in harder and faster. Even so, aspiring homeowners planning for longer mortgages such as those for 30 years need to reassess whether they can afford them amid fast-rising higher rates. The carry trade will end as the rate differences will equalise. But make no mistake; the higher rate environment is here to stay. Hong Kong people need to be aware of the risks associated with the rising cost of money, which will – sooner or later – spill over into higher mortgage rates, and higher borrowing costs for businesses and individual borrowers.