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Hong Kong Key Rate Surge to Ease Pressure on Local Currency

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(Bloomberg) — A gauge of Hong Kong borrowing costs surged past its US dollar equivalent for the first time since February, a move that’s expected to reduce pressure on the local currency spurred by the Federal Reserve’s rate hikes.

The three-month Hong Kong Interbank Offered Rate rose to the highest since 2007, exceeding the same tenor London Interbank Offered Rate for the first time in eight months. That’s expected to deter traders from shorting the Hong Kong dollar on the back of a higher-yielding greenback and bring relief to the local currency which has been lingering near the weak end of its trading band over the last two months.

While Hong Kong’s official interest rates move in lock-step with those of the Fed, excess cash in the city’s banking system had been keeping interbank rates anchored and driving carry trades against the local currency. To maintain Hong Kong’s currency peg with the greenback, the city’s de-facto central bank has shrunk interbank liquidity by 70% since May, a move aimed at pushing up local rates and slowing outflows.

“This negation of the positive rate spread should lead to a significant reduction of the upside pressures on the USD/HKD exchange rate that has been evident since May,” said Alvin. T. Tan, head of Asia FX strategy at RBC Capital Markets. “That said, the broad US dollar uptrend against Asian currencies suggests that the expected correction in USD/HKD will be a gradual one.”

While further aggressive Fed hikes could delay the Hong Kong dollar’s recovery, a narrowing yield gap is taking some pressure off the currency for now. The Hong Kong dollar rose the most in two months on Monday before trading at 7.8497 per greenback on Wednesday ahead of the Fed’s rate decision. It has a 7.75-7.85 trading band with the dollar.

Hong Kong will stick with its dollar peg, which is backed by strong buffers, deep foreign-exchange reserves and the city’s robust banking system, HKMA Chief Executive Eddie Yue said in a Bloomberg TV interview.

Even as carry trades in the three-month tenor turned unattractive, a gauge of one-month Hong Kong rates still remains more than 50 basis points below equivalent Libor, a sign that local rates need to rise more to support the currency. The city’s aggregate balance, a gauge of interbank liquidity, may need to halve from current levels to stem the currency’s decline, analysts say.

There’s still carry interest to go long greenback in shorter tenors, according to Mizuho Bank Ltd. “But in the three-month horizon we may see Hong Kong dollar weakness take a breather if the Fed indicates signs of slowing the pace of rate hikes,” said Ken Cheung, chief Asian FX strategist at the bank.

Still, rising local rates could pose a threat to Hong Kong’s economy, which just posted its worst quarter in more than two years amid rising borrowing costs and Covid restrictions in the city.

“The higher funding costs have likely weighed on private sector investment, including the housing market as most loans are benchmarked against Hibor rates,” wrote Erin Xin, Greater China economist at HSBC Holdings Plc in a note.

(Updates prices in 5th paragraph and adds HKMA comment in the sixth paragraph.)

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