Hong Kong Intervenes to Defend Peg as Upper Limit Tested

Hong Kong Intervenes to Defend Peg as Currency Tests Upper Limit
The central bank fixed the currency in 1983 when negotiations between China and the U.K. over the city’s return to Chinese rule stoked capital outflows. Photographer: Jerome Favre/Bloomberg

The Hong Kong Monetary Authority sold its own currency for the second day in a week to stem appreciation after it touched the upper limit of a 29-year-old peg to the U.S. dollar.

The central bank bought a combined $1.25 billion at a rate of HK$7.75 per U.S. dollar in Hong Kong and New York yesterday, the authority said in an e-mailed statement. That followed a $603 million intervention on Oct. 19, when it stepped into the market for the first time since 2009. The city had $301.2 billion of foreign-exchange reserves as of the end of September, amounting to about eight times the currency in circulation. The holdings grew 8.5 percent in the past year.

“The capital inflows will keep sending the currency to test the strong end of the peg,” Stella Lee, president of Success Futures & Foreign Exchange Ltd. in Hong Kong, said by telephone today. “There could be more intervention.”

The central bank fixed the currency in 1983, and in 2005 committed to keep the exchange rate between HK$7.75 and HK$7.85. The link has given Hong Kong companies stability in commercial contracts while tethering monetary policy to that of the U.S., where borrowing costs are being held down to spur hiring and prop up the housing market. Hong Kong’s jobless rate is near a four-year low and home prices are at all-time highs.

The Hong Kong dollar was at HK$7.7502 as of 10:28 a.m. in the city today, according to data compiled by Bloomberg. Local financial markets were closed yesterday for a public holiday. Two-year forwards on the currency strengthened 0.06 percent to HK$7.7357 versus the greenback, climbing for a sixth day to the strongest level since Dec. 6, 2011. That compares with an average of HK$7.7368 in the past three years.

Asset Bubbles

Policy makers from around the world have bemoaned the economic threat of stronger exchange rates as asset purchases by the Federal Reserve boost the supply of dollars. At International Monetary Fund meetings in Tokyo this month, Philippine central bank Governor Amando Tetangco said the Fed was causing “challenges to monetary policy in emerging markets.”

The HKMA first intervened during Hong Kong hours yesterday by buying $505 million and bought a further $350 million later, it said in e-mailed statements. It then purchased $395 million in New York, according to a later e-mail.

‘No Choice’

“They will have no choice but to keep intervening,” Irene Cheung, a currency strategist in Singapore at Australia & New Zealand Banking Group, said by telephone yesterday. “The Hong Kong dollar’s strength reflects the capital flows we see into most Asian currencies.”

Home prices that surpassed their October 1997 peak and rising costs of food imports are increasing the risk of asset bubbles in Hong Kong and fueling calls for a review of the peg. The link will remain because conditions for a possible alternative peg to the yuan, such as currency convertibility, aren’t in place, Goldman Sachs Group Inc. said in a report yesterday.

ANZ Group’s Cheung expects the Hong Kong dollar peg to stay and predicts the currency will weaken toward HK$7.80 during the next three months.

“We are not in an episode of a persistent weak dollar as the U.S. economy has been doing well lately and could damp risk appetite,” Cheung said by telephone yesterday.

U.S. data this month showed gains in retail sales beat economists’ estimates in September, as manufacturing unexpectedly expanded and the unemployment rate declined. The world’s biggest economy probably grew at an annual pace of 1.9 percent in the third quarter versus 1.3 percent in the prior three months, according to the median forecast in a Bloomberg News survey before a Commerce Department report on Oct. 26.

Aggregate Balance

When the Hong Kong dollar reaches the so-called strong end of the permitted trading range, the HKMA offers to buy U.S. dollars to prevent further appreciation under its currency board system. The latest intervention “will result in a corresponding expansion in the banking system’s aggregate balance to HK$163 billion on Oct. 25,” according to the e-mail from the monetary authority’s New York office.

The pressure on the peg arose from capital inflows into the region, the HKMA said in a statement on Oct. 20.

One-year implied volatility in the Hong Kong dollar, a measure of exchange-rate swings used to price options, rose 10 basis points, or 0.1 percentage point, to 1.21 percent today, according to data compiled by Bloomberg. That’s the highest level since June 1. China’s yuan fell 0.04 percent to 6.2502 per dollar in Shanghai.

Quantitative Easing

The Fed initiated a third phase of so-called quantitative easing on Sept. 13, purchasing $40 billion of mortgage-backed securities per month, and said this will continue until the outlook for jobs improves “substantially.”

The European Central Bank and Bank of Japan have also added to stimulus. The ECB pledged last month to buy the bonds of governments that agree to austerity conditions while the BOJ boosted its asset-purchase fund by 10 trillion yen ($125 billion) and abandoned a minimum yield for the bonds it purchases.

Hong Kong’s benchmark Hang Seng Index of stocks has risen 8.1 percent since the Fed’s announcement and gained about 20 percent from this year’s low on June 4.

Emerging-market equity funds tracked by EPFR Global Research recorded their sixth straight week of inflows for the week ended Oct. 17, bringing the total to more than $21 billion this year, according to a statement from the company. Commitments to China equity funds reached a seven-week high, with flows attributable to domestically domiciled funds at the highest level in more than four months, it said.

“The HKMA will remain closely vigilant of the market developments and act in accordance with the currency board mechanism to maintain the exchange rate stability of” the Hong Kong dollar, the authority said yesterday.

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