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Hong Kong dollar weakens to January 2016 low

The Hong Kong dollar has fallen to its weakest level since the China-inspired turmoil of January 2016 as abundant liquidity holds down interest rates in the Chinese territory.

While the Hong Kong currency has been tightly pegged to the US dollar since 1983, its gradual weakening this year is attracting the attention of analysts speculating it could at some point breach the lower end of its permitted HK$7.75 to HK$7.85 trading band – forcing the Hong Kong Monetary Authority to act.

On Wednesday it reached HK$7.8158 against the greenback (see chart above).

While the currency’s dollar peg means that in theory its interest rates should track the US, abundant liquidity – aided by inflows from the mainland – have held Hong Kong rates down. The spread between three-month US money market rates and their Hong Kong equivalent has now reached its widest point since the collapse of Lehman Brothers in September 2008.

Three-month US Libor stands at 1.31 per cent while its Hibor equivalent is 0.763 per cent.

Hong Kong’s currency peg mandates the HMKA to use its considerable reserves to buy up the currency if it hits the weaker end of the trading band. While the ability of the city to defend its peg is not currently in doubt, the fear is that any action will drain liquidity and sharply raise borrowing costs in the territory.

Chart: Bloomberg