What the Hong Kong Dollar Peg Is and Why It Matters

Pegged to the US dollar since 1983, the Hong Kong dollar is usually a dull currency. Except when it isn’t, like this year. When the US Federal Reserve began raising interest rates in March to combat historically high inflation, fund outflows from the Hong Kong dollar market intensified as investors chased higher yields. Consequently, interbank liquidity -- the pool of Hong Kong dollars in the system -- shrank rapidly as the city fought to maintain the peg, drawing market attention and concern about the impact on the struggling local economy.

The Hong Kong Monetary Authority, the de-facto central bank, has a mandate to keep the currency trading at HK$7.75 to HK$7.85 per US dollar. The current band was set in 2005 and has never been broken. When it gets too close to one end or the other, the HKMA intervenes, either by buying or selling the city’s dollars. When HKMA uses its foreign exchange reserves to buy Hong Kong dollars from the commercial banks, the aggregate balance of Hong Kong dollars in the banking system -- interbank liquidity -- goes down accordingly. From May 11 through November, the HKMA’s intervention shrank the balance by more than 70%. That tighter liquidity pushes up local borrowing costs.