Hong Kong dollar falls most in 22 months as HKMA says it won’t defend drop to lower end of the peg

The Hong Kong dollar plunged the most in 22 months after the city’s de facto central bank said it will not seek extra exchange fund bills and that it would let the currency fall to the weak end of the currency peg.

Bloomberg reported Hong Kong Monetary Authority (HKMA) chief executive Norman Chan Tak-lam as saying on Thursday that the authority had no plans to sell additional debt as the demand for exchange fund bills was largely met.

Since August, the HKMA had been selling exchange fund bills to absorb excessive liquidity in the financial system. As a result, one-month Hibor, a gauge of funding levels in the interbank market, climbed about 67 basis points to its current level of 1.09 per cent, which in turn narrowed the gap with US rates.

Earlier this year, the gap between Hong Kong and US interbank rates was larger, which attracted a popular “carry trade” in the market – when speculators continued selling Hong Kong dollars at a relatively low interest rate and used the funds to purchase higher US yielding assets, which caused the local currency to slide towards a 10-year low.

But the HKMA’s decision Thursday appears to deny such market expectations and may suggest that it does not want to tighten liquidity conditions too aggressively, and is avoiding excessively rapid increases in interbank rates, analysts said.

“Liquidity conditions have changed and it is much tighter now compared to previous loose levels,” said Jasper Lo, chief strategist at King International Financial Holdings. “The local currency is probably weakening now because of emerging capital outflows rather than carry trade speculation.”

Chan’s comments follow the decision to raise the base lending rate by 25 basis points to 1.75 per cent early on Thursday, in line with the Federal Reserve’s decision to raise interest rates by the same magnitude on Wednesday.

Chan denied that the HKMA was refraining from selling debt to help the Hong Kong dollar to depreciate to the 7.85 level, the currency’s weak-side which would trigger buying of local currency by the Currency Board.

“I would like to point out that under the design of the Linked Exchange Rate System, the outflow of capital, weakening of the Hong Kong dollar exchange rate, triggering of the weak-side convertibility undertaking, and the reduction in the monetary base are part of the necessary process of Hong Kong dollar interest rate normalisation,” HKMA’s Chan said in a statement. “The triggering of the weak-side convertibility undertaking is something that the HKMA is expecting.”

The Hong Kong dollar drifted higher after the Fed’s move but swung to losses after the HKMA statement, dropping 0.11 per cent to HK$7.8124 against the dollar in its biggest daily decline since February 2016.

Mizuho Bank’s Senior Asian currency strategist Ken Cheung Kin Tai said he expected market participants to push the Hong Kong dollar to 7.8278 in coming weeks before hitting the 7.85 level, saying the HKMA has granted the greenlight for the drop.