Hong Kong dollar peg to remain intact despite pressure

Hong Kong's foreign exchange reserves allows the central bank to maintain the peg.

According to BMI Research, the Hong Kong dollar has been under downside pressure against the US dollar since the beginning of 2017, and in our view, this has been due to widening interest rate differentials of the territory versus that of the US as the US Federal Reserve signals that it will continue its interest rate hiking cycle.

This has resulted in capital outflows as the attractiveness of the city's assets decline, with the HKD at its lowest level in 14 months and appearing to be heading towards the lower end of the Hong Kong Monetary Authority (HKMA)'s lower band of its peg against the US dollar at HKD7.85/USD.

Here's more from BMI Research:

That said, we continue to believe that the HKMA's Hong Kong dollar peg to the US dollar is likely to remain firmly intact. The HKMA's foreign exchange reserves, which stood at USD400bn at the end of April (equivalent to approximately 123% of GDP) is substantial and allows the central bank to maintain the peg in the event of difficult market conditions and aggressive selling of the HKD. Indeed, the peg was able to survive the Asian Financial Crisis in 1997-98, despite reports that there were attacks on the currency, and also the Global Financial Crisis.

In addition, continued capital outflows would lead to tightening liquidity and an upward adjustment in domestic interest rates in Hong Kong to match that in the US, which should help to stabilise the Hong Kong dollar over the coming months. We note that Hong Kong's commercial banks, which independently decide their interest rates provided to savers and borrowers, have not adjusted their interest rates.

This is despite the HKMA raising its base rate to 50bps higher than the lower end of the US Fed funds rate of 0.75% to 1.00% following the decision by the US Fed to raise interest rates by 25bps at its March monetary policy meeting.

In the short-term, significant liquidity in the banking system and fierce competition have allowed banks to keep their lending rates low (with the 1-month Hong Kong Interbank Overnight Rate [HIBOR] declining versus an increase in the 1-month USD LIBOR), but this is unlikely to persist as US interest rates gradually edge higher over the coming years. Our US team's outlook for interest rates is further hikes of 50bps in 2017, 50bps in 2018, and 50bps in 2019.