Hong Kong steps up defence of currency’s US dollar peg as fixed range tested again

HONG KONG - Hong Kong’s de facto central bank ramped up purchases of the city’s currency as it sought to defend a peg that has been strained by volatility in the US dollar.

The Hong Kong Monetary Authority (HKMA) said on July 2 that it bought HK$20.02 billion (S$3.25 billion) of the city’s currency after indicative pricing suggested the local dollar touched the weak end of its permitted trading range in late New York trading overnight.

That is more than double the HK$9.42 billion it purchased last week. 

The Hong Kong dollar was little changed at 7.8497 on July 2, after the intervention.

The Hong Kong dollar has been through a roller-coaster ride in recent months, swinging between both ends of its trading range. And for the first time since the current band came into effect in 2005, the authorities had to defend the peg on both sides within just one year. 

The wild swings have also intensified debate about the sustainability of the currency’s peg, even though there are no signs that a change is imminent.

Market watchers had talked about the possibility of widening the narrow peg, linking the Hong Kong dollar to China’s renminbi or even free-float the currency altogether. 

In May, a slump in the US dollar spurred a rush for Hong Kong’s currency, prompting the HKMA to flood the financial system with cash in an effort to cool the rally that threatened the 7.75-per-US dollar strong end of the band.

The operation, however, triggered a sharp reversal of the city’s dollar, and it plunged all the way to 7.85, the opposite end of the trading range. 

Still, even after the latest round of intervention this week, Hong Kong’s aggregate balance – a component of its monetary base – will only fall to HK$144.2 billion.

That means the supply of cash will remain abundant and local funding costs are still low. 

Therefore, the so-called carry trade, which involves traders borrowing the Hong Kong dollar cheaply and selling it against higher yielding greenback, is still lucrative.

So the local currency can still hit the weak end of the band soon again, analysts say.

“It may take more time for liquidity conditions to normalise this time around, and intervention will go on as long as (the) flush liquidity condition continues,” said InTouch Capital Markets strategist Andy Ji.

Now, all eyes are on Hong Kong’s interbank rates, known as Hibor, which has remained low despite the HKMA’s liquidity drainage.

The spread between one-month Hibor and its US counterpart stood near a record high earlier this week. BLOOMBERG