This latest intervention, which more than doubled last week’s HK$9.42 billion purchase, underscores the challenges faced by the city’s Linked Exchange Rate System. The system keeps the Hong Kong dollar trading between 7.75 and 7.85 per US dollar by requiring the HKMA to buy or sell the local currency as needed. When the rate approaches the weak end, the HKMA buys Hong Kong dollars, draining liquidity from the banking system in the process.
The backdrop to these moves is months of heightened volatility. In an unusual development for the peg, the HKMA has had to intervene at both the strong and weak ends of the trading band within a single year—the first time this has happened since the band was established in 2005. Earlier this year, a sharp slump in the greenback prompted heavy buying of the Hong Kong dollar, pushing it toward 7.75. To counter that, the HKMA injected liquidity into the system to cool the rally. But as the dollar regained strength, the local currency swung to the opposite extreme.
Such swings have fueled debate about the future of the peg, with some analysts and market participants speculating on whether Hong Kong might eventually consider widening the band, linking the currency to the Chinese yuan, or even allowing it to float freely. For now, however, officials have given no indication of any plan to change the system.
Despite the HKMA’s latest move to withdraw cash from the market, liquidity remains ample. Hong Kong’s aggregate balance—a key measure of banking-system cash—will still stand at about HK$144.2 billion after the intervention. This abundance of liquidity keeps local funding costs low. The one-month Hong Kong interbank offered rate (Hibor) remains subdued at around 0.72%, even after the currency-buying operation.
This situation supports the so-called “carry trade,” where investors borrow cheaply in Hong Kong dollars to fund purchases of higher-yielding assets, often in US dollars. Such trades put persistent downward pressure on the local currency, making it likely that the HKMA will need to continue intervening.
“It may take more time for liquidity conditions to normalize this time around, and intervention will go on as long as flush liquidity condition continues,” said Andy Ji, a strategist at InTouch Capital Markets.
Meanwhile, the spread between one-month Hibor and its US equivalent remains wide at about 360 basis points, offering little immediate prospect of deterring currency bears. As Mark Cranfield, a strategist in Singapore, noted: “The Hong Kong Monetary Authority may need to stay on FX intervention watch for an extended period as short-term HKD rates are showing little indication of rising to a level which would dissuade currency bears.”
HKMA Chief Executive Eddie Yue recently sought to reassure the market, describing the Hong Kong dollar’s move to the weak end of the band as consistent with the intended functioning of the Linked Exchange Rate System.
Still, many analysts expect further rounds of buying. “We will see more intervention — with that attractive carry, the question is when, not if,” said Ryan Lam, head of research at Shanghai Commercial Bank Ltd. He predicts one-month Hibor will gradually normalize toward 2% by year-end.
As of Wednesday, the Hong Kong dollar was trading little changed at 7.8499 per US dollar, hovering just shy of the weak end of its trading band.