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Hong Kong hopes to placate fears over future of its dollar peg

Market Watch
Despite pressure from US monetary policy and Chinese economic performance, Hong Kong’s central bank is confident it can defend its currency peg

Despite pressure from US monetary policy and Chinese economic performance, Hong Kong’s central bank is confident it can defend its currency peg

Caught between tightening US monetary policy and economic troubles in China, the Hong Kong dollar peg is under increasing strain. In face of the HKD reaching an eight year low against the USD, and a growing number of bets against the peg, the Hong Kong Monetary Authority, which effectively functions as the country’s central bank, is keen to make it clear that they have the means and the will to the defend their fixed exchange rate mechanism.

Since the 1980s, the HKD has been pegged to the US dollar. This linked exchange rate system allows the HKD to fluctuate within an extremely narrow range against the USD. Having been unchanged for three decades, the linked exchange rate mechanism is generally seen as one of the most credible currency pegs in the world.

However, as investor confidence in China wanes, with the mainland seeing the largest capital flight in history, jitters have spread to the Hong Kong economy. Hong Kong is now also seeing cash increasingly flow out of its economy, which has put downward pressure on the value of the HKD. An appreciating USD and an interest rate hike by the US Federal Reserve at the end of 2015 has further exacerbated this.

As a result, the HKD has been falling within the linked exchange mechanism’s tradable band against the USD. The HKD, which can trade between 7.75 and 7.85 against US currency, hit a low of 7.82 in January 2016. Further, forward exchange markets also suggest that some traders are speculating that in the near future the tradable band within the exchange mechanism may be relaxed or possibly abandoned.

To placate these fears, the Hong Kong Monetary Authority has attempted to make it clear that it has the foreign currency reserves to fight off and speculation. If the price of HKD falls beyond the tradable band, the city-state’s Monetary Authority is required to intervene, using foreign exchange reserves. According to the Monetary Authority, these foreign exchange reserves currently amount to US$358.9bn, more than the amount of currency in actual circulation, giving it ample room to buy up local currency to shore up its value.

Such large reserves also allow Hong Kong officials to guard against attempts by currency speculators to short the UKD. As Wilson Chan, an economics and finance professor told the South China Morning Post, “speculators need much greater fire power to break it since the Hong Kong Monetary Authority has a huge war chest.” The linked exchange rate system, it seems, is safe for now.

 

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