Why Hong Kong’s Central Bank Intervened and Should We Worry?

(Bloomberg) -- After buying Hong Kong dollars for the first time since 2005 in April and May, Hong Kong’s central bank is at it again. A long slide in the local currency took it to the lower end of its trading band against the U.S. dollar. The Hong Kong Monetary Authority has lifted its spending to defend the local dollar to more than $9 billion. That’s raising questions about how long this can continue and the implications for the city’s finances.

1. Should we be worried?

Not for now. The central bank had $432 billion of foreign reserves as of end-July (seven times the city’s money in circulation), so the interventions so far only accounted for about 2 percent of the total. The HKMA and the city’s government are resolute about maintaining the dollar peg that’s been in place for 35 years. What might rock the boat would be massive speculative attacks on the currency, as experienced in 1997. But even then, the central bank held sway.

2. What happened in 1997?

As the Asian financial crisis unfolded, excessive optimism in Hong Kong stocks quickly turned into panic selling and triggered a run on the currency. But the HKMA held firm against speculators, allowing overnight interest rates to jump to 300 percent and making it harder for banks to borrow money overnight. This was enough to kill off the hedge fund attack as local banks could only raise funding for their own needs, so there were no Hong Kong dollars left to finance short sellers.

3. Are speculators targeting the currency this time?

It doesn’t look that way. The HKMA said in April it didn’t see any large-scale shorting of the Hong Kong dollar. On Aug. 15, it said lower local interest rates than in the U.S. was the key reason for the currency weakness. Activity among options trading -- an indicator of increased speculation -- remains subdued. The latest weakness in the local dollar stems from U.S. dollar strength amid a selloff in some emerging market currencies.

4. Does the central bank see a weak currency as a problem?

Not according to its chief, Norman Chan. He said in March the authorities were "looking forward to" seeing the currency reaching 7.85 per U.S. dollar, the level at which the central bank is mandated to take action. (The band has been $7.75 to $7.85 since 2005). That’s because such action would allow interest rates to rise -- counteracting the key reason why the Hong Kong dollar has been weakening.

5. So this could all resolve itself soon enough?

Some analysts see it that way. In buying local dollars, the HKMA is addressing the very reason local interest rates are not advancing in synch with U.S. rates: the abundance of liquidity in Hong Kong. With its intervention, the central bank is draining that excess. Indeed, home loan rates just had their biggest jump in five years. Inter-bank borrowing costs have been on an uptrend too.

The Reference Shelf

  • A QuickTake explainer on how the Hong Kong dollar got so weak.
  • Bloomberg’s Mark Cranfield expects a “war of attrition” and recalls the lessons of 1997.
  • Bloomberg’s Fion Li recalls the peg turning 30.

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