HONG KONG – Hong Kong’s de-facto central bank spent more than a billion dollars propping up the city’s exchange rate, as it sought to defend a currency peg that has been strained by volatility in the greenback.
The Hong Kong Monetary Authority (HKMA) took out HK$9.42 billion (S$1.5 billion) of the city’s currency from circulation after the exchange rate touched the weak end of its US dollar peg. In earlier weeks, the monetary authority had injected liquidity into the financial system to rein in gains in the local exchange rate as the US currency declined.
The currency rose as high as 7.8469 per US dollar in the morning session in Asia on June 26, before paring the gain to trade around 7.8493.
In addition to pushing the currency back into its permitted trading range of 7.75-7.85 per greenback, the HKMA’s latest move will also make bearish bets more costly. It does this by draining liquidity from the financial system and driving up borrowing costs.
The one-month Hibor rate rose to 0.97 per cent after the HKMA’s intervention, the highest level since May 19. The gap between one-month US and Hong Kong rates stands at well over 300 basis points.
When Hong Kong dollar’s funding costs are significantly lower than those in the greenback, traders tend to borrow the city’s currency and sell it against its higher-yielding US counterpart to earn the interest-rate difference. That’s made it the world’s most rewarding carry trade over the past month by one measure.
The intervention follows a rollercoaster ride for the Hong Kong dollar that has seen it swing between both ends of its trading range as authorities sought to protect the currency peg. The volatility has intensified debate about the sustainability of the fixed exchange rate, even though there are no signs that a change is imminent.
The HKMA is signalling that funding for carry trades is going to be more expensive and USD/HKD will not rise much further, said Rodrigo Catril, a currency strategist at National Australia Bank in Sydney. “For markets, the big question is: do you believe the peg will be protected? For now, authorities are showing that they are very much willing to defend it.”
When asked about the prospect of further intervention, the HKMA referred to its website which says the monetary authority is committed to buying local dollars if the currency hits the weak end of the band.
The HKMA’s predicament stands in contrast to the dilemma faced by most other Asian central banks, which are trying to cool their currencies’ gains as the dollar declines.
It was just in early May when the Hong Kong dollar advanced to 7.75 per dollar as the greenback weakened, prompting the HKMA to step in to check its gains. Authorities pumped in US$16.7 billion (S$21.4 billion) worth of local dollars into the financial system, driving it to the weaker end of the band.
The HKMA’s move to intervene at both ends of the trading range in the same year is “a first since the city’s de facto central bank reformed the peg system into a band in May 2005,” Stephen Chiu, chief Asia FX and rates strategist at Bloomberg Intelligence, wrote in a note.
“If the current, more frequent touching of the band becomes the new norm, reduced stability in the Hibor might not be constructive for businesses operating in the city – particularly the property sector,” Mr Chiu wrote. “Subsequently, it may be natural for authorities to study whether the peg parameters should be modified – for example, the band width and even the peg target.”
Hong Kong will maintain its currency’s peg to the US dollar as it is a key success factor, Chief Executive John Lee Ka-chiu told local media in early June, after a bout of volatility fuelled speculation about alternatives to a dollar peg.
The latest intervention will reduce the city’s aggregate balance, a closely-watched component of its monetary base and gauge of interbank liquidity to HK$164 billion, the HKMA said. Hong Kong also has $431 billion in foreign currency reserves, according to the latest data for May. BLOOMBERG
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