The Hong Kong dollar has fallen to its weakest level since the China-inspired turmoil of January 2016 as abundant liquidity continues to create a widening interest rate gap with the US.
The move pushed the Hong Kong currency further into the weaker half of its tightly pegged trading range against the US dollar — in a shift from its position for most of the past decade of trading near the stronger end.
Wednesday’s weakness took the currency to HK$7.8171 against the greenback — a level not seen since January 2016 when fears about China’s weakening economy sent shockwaves through global markets.
The Hong Kong dollar is one of only two Asian currencies to lose ground against the weakening dollar. So far this year it is down 0.8 per cent, while the Philippine peso is 1.3 per cent weaker.
The Hong Kong currency’s steady slide is attracting the attention of analysts who suggest it could at some point breach the lower end of its permitted HK$7.75 to HK$7.85 trading band — which would force the Hong Kong Monetary Authority to support the currency and potentially produce a sharp rise in interest rates.
Since the current peg regime was set in 2005, the HKMA has only had to intervene at the strong side of the band when the currency was lifted by inflows during periods of financial stress elsewhere, or to cope with international demand for Hong Kong dollars during some of the city’s record-setting initial public offerings.
Hong Kong has more recently benefited from inflows produced by central banks’ unprecedented quantitative easing following the financial crisis as well as inflows from China.
While both sources of funds have tailed off recently, the cash already in the Hong Kong banking system has helped suppress money market borrowing costs, meaning that even as the HKMA has followed the US in raising interest rates, the city’s money market rates have not kept pace.
Benchmark three-month US Libor, or the London Interbank Offered Rate, is at 1.31 per cent while its Hibor equivalent is at just 0.763 per cent. Last week, the gap between the two reached its widest since the collapse of Lehman Brothers in September 2008.
Hong Kong’s currency peg mandates the HKMA to use its reserves to buy the currency if it hits the weaker end of the trading band and it could potentially act before that point is reached.
Last month, HKMA head Norman Chan defended the 33-year-old peg and set out the conditions that would need to be met before the city’s de facto central bank would even consider shifting to a peg with the renminbi.
These included China’s currency being fully convertible and China dropping all capital controls.
“Keeping a stable exchange rate between the Hong Kong dollar and the US dollar is the most suitable arrangement,” Mr Chan said. “We have no need and no intention to change such an effective system.”