Hong Kong Raises Base Rate After Fed, Sees Potential Outflow

Updated on
  • City follows Fed's quarter-point move to maintain dollar peg
  • HSBC leaves best lending rate unchanged citing ample liquidity

The Hong Kong Monetary Authority raised its base rate for the first time in nine years, following the U.S. Federal Reserve’s lead overnight, and flagged the risk of rising capital outflows from the city.

Hong Kong’s key rate was raised to 0.75 percent Thursday, from 0.5 percent, HKMA said. Because Hong Kong’s currency is pegged to the U.S. dollar, the city’s monetary policy typically moves in line with the Fed. 

The monetary authority had held its rate at a record low since 2008, tracking the Fed as the U.S. brought its benchmark down to near zero to combat the financial crisis. The Fed increased the target range for its main rate by a quarter point, and with Chair Janet Yellen saying Wednesday that further "gradual" tightening will come in the U.S., Hong Kong’s slowing economy now also faces the prospect of higher borrowing costs. 

The Fed’s decision means that emerging-market economies will continue to experience capital outflows and downward pressure on their exchange rates, economic growth and asset markets, HKMA Chief Executive Norman Chan told reporters Thursday.

"The speed of outflows from the Hong Kong dollar will depend on U.S. interest rate hikes and the interest-rate differential between the U.S. dollar and Hong Kong dollar," Chan said. "If, for whatever reason, the U.S. interest rate rises faster than expected, then the outflows from the Hong Kong dollar and corresponding rise in interest rates will also be quicker."

While Hong Kong’s economy has weakened with China growing by the least in a quarter century, the city’s policy makers remain committed to the link to the greenback. The peg was set in 1983, when negotiations between the U.K. and Beijing over the city’s return to Chinese rule spurred an exodus of capital.

In 2005, policy makers committed to limiting the currency’s decline to HK$7.85 per dollar and capping gains at HK$7.75. The Hong Kong dollar traded at 7.7510 versus the greenback as of 3:28 p.m. local time, according to data compiled by Bloomberg.

Chan said the central bank’s $355.8 billion foreign exchange reserves are enough to cushion the impact of the Fed’s new tightening cycle. "We presently expect the rise in Hong Kong dollar interbank rates to be incremental," he said.

Despite China’s slowdown, Hong Kong’s economy grew more than economists expected in the third quarter, boosted by improved domestic demand. Gross domestic product expanded 2.3 percent in the three months through September from a year earlier.

Rising borrowing costs are set to weigh on the city’s real estate market, said Trinh Nguyen, senior economist for emerging Asia at Natixis.

Feel the Pinch

"Hong Kong interest rates will gradually rise, in line with the Fed’s," she said. "Obviously, the housing market will feel a pinch from this, not a good trend considering there’s already a downturn of retail sales in the city."

Property foreclosures will double from current levels by the end of next year as a slowing economy hurts borrowers’ ability to service their mortgages, according to Tsang Kit-chun, Managing Director of AA Property Auctioneers Ltd.

Still, with growth robust and unemployment low, the rate hike can be absorbed, said John Zhu, Hong Kong-based economist at HSBC Holdings Plc.

"Given the current state of Hong Kong’s economy, you would say it would be probably something that Hong Kong can handle," he said.

Another positive: banks in the former British colony are awash with near-record levels of interbank funds, which gives them scope to resist passing on the rate hike. China’s yuan devaluation in August helped drive the aggregate balance of funds in Hong Kong’s banking system to HK$426 billion ($55 billion) on Nov. 4, the highest level since at least 1997.

While that level had fallen to HK$391 billion as of Tuesday, Australia & New Zealand Banking Group Ltd. estimates that’s more than enough for banks to conduct day-to-day lending operations until early next year before they have to react to higher interbank funding costs.

HSBC left its best lending rate unchanged at 5 percent as the city’s financial system has ample liquidity, Diana Cesar, its chief executive for Hong Kong, said in an email on Thursday. Standard Chartered Plc left its rate at 5.25 percent, the company said in a statement.

— With assistance by Dominic Lau, and Alfred Liu

(Updates with HSBC, Standard Chartered leaving best lending rate unchanged in final paragraph.)
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