Pegged to the U.S. dollar since 1983, the Hong Kong dollar is usually a dull currency. Except when it isn’t. While its trading band of HK$7.75 to HK$7.85 per U.S. dollar, set in 2005, has never been broken, it keeps getting tested. That forces the Hong Kong Monetary Authority, the de-facto central bank, to follow its mandate and intervene, raising questions about how long this can continue and the implications for Hong Kong’s wider economy.

1. Should we be worried?

Not for now. Despite all its interventions, the city still has more than $430 billion of foreign reserves, or seven times the Hong Kong dollars in circulation. The city also has more than HK$1 trillion ($127 billion) of exchange fund bills outstanding, so it could inject cash by allowing that debt to mature. What might rock the boat would be massive speculative attacks on the currency as experienced in the midst of the Asian financial crisis in 1997. Even there, the central bank won. And of course Hong Kong has a special connection with China, which has the world’s largest foreign-exchange reserves at more than $3 trillion.

2. What happened in 1997?

As the crisis that began with a devaluation of the Thai baht spread, optimism in Hong Kong stocks quickly turned into panic selling and triggered a run on the currency. The monetary authority held firm against speculators, allowing overnight interest rates to jump to 300 percent as cash drained out of the interbank market, where banks exchange different currencies. This was enough to kill off the hedge-fund attack as local banks could only meet their own needs, so there were no Hong Kong dollars left to finance short sellers.

3. What moves the Hong Kong dollar these days?

Often it’s interest rates, when local ones don’t move in tandem with the U.S. For example, as the Federal Reserve kept raising rates in 2018, it became more attractive for investors to sell local dollars and buy higher-yielding U.S. dollars. The Hong Kong dollar fell to the lower end of its trading band that April, so the HKMA began buying. Then, in one dramatic trading session on Sept. 21, 2018, the Hong Kong dollar surged out of the danger zone. Analysts at the time cited the prospect of higher rates in the city, stop-loss orders and even upcoming holidays as likely triggers. Whatever the reason, it didn’t last, and interventions resumed in 2019. In the week of March 9-15 the authority spent about $700 million buying Hong Kong dollars.

4. Why doesn’t Hong Kong mirror the Fed?

It tries to. Every time the Fed lifts its benchmark rate, the HKMA raises its base rate, but with little effect. That’s because the base rate is the one at which the authority offers overnight funds to banks -- hardly relevant when the banking system has been brimming with cash for years. Hong Kong, as a financial hub, drew massive inflows as the world’s major central banks printed money in response to the global financial crisis. The city also benefited from an exodus of capital from mainland China as investors sought to diversify their portfolios, at least until Chinese officials tightened capital controls to support a weakening yuan in 2015-16. Flush with cash, Hong Kong banks are under little pressure to raise interbank interest rates significantly.

5. How long will this last?

Multiple interventions in 2018 have more than halved that cash pool, known as the aggregate balance of interbank liquidity, because the monetary authority has been buying up Hong Kong dollars from them. Right now, it sits at just over HK$70 billion (about $9 billion), low relative to recent history, but the gap between Hong Kong and U.S. borrowing costs remains wide. Some analysts say Hong Kong will need to spend another HK$40 billion to HK$60 billion to make local borrowing costs more responsive to intervention. Hibor, the floating rate on most new mortgages, is the first indicator of tightening liquidity. The one-month rate fell to as low as 0.91 percent in February, compared with 2.49 percent for U.S. Libor, but climbed to 1.55 percent as of March 15.

6. Why does keeping the peg matter?

First and foremost, the currency peg is considered an anchor for financial stability and the economy. Investors park their money in Hong Kong because the currency is relatively safe. At the same time, Hong Kong’s property market, one of the world’s most expensive, is showing signs of cooling off with borrowing costs likely to rise. Local lenders raised the prime rate, which is often the basis of a cap on mortgages, for the first time in more than a decade in September. Citigroup Inc. and CLSA Ltd. are among those forecasting declines in home prices.

To contact the reporter on this story: Tian Chen in Hong Kong at tchen259@bloomberg.net

To contact the editors responsible for this story: Sarah McDonald at smcdonald23@bloomberg.net, Paul Geitner, Grant Clark

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