The Federal Open Market Committee of the Federal Reserve (US Fed) announced a rate hike in the early morning today (Hong Kong time) following its two-day meeting, raising the target range for the federal funds rate by 25 basis points to 0.25-0.5%.  In accordance with the established mechanism, the HKMA has raised the Base Rate for the Discount Window by 25 basis points to 0.75% with immediate effect.  The US Fed also indicated that ongoing increases in interest rate would be appropriate amid persistently high inflation and expected to begin balance sheet reduction at a coming meeting.

The market has been very focused on the US rate hike and recent volatilities in the global financial environment.  The relevant discussion has also touched upon the impacts on Hong Kong’s financial stability and monetary market.  We have summarised some common market discussion and shared our views to facilitate understanding by the public.

Q1: The global geopolitical and economic environments have been very uncertain recently.  Amid sharp fluctuations in the Hong Kong stock market for consecutive days, how would the HKMA assess the relevant impacts on Hong Kong’s economic and financial outlook?

A1: Recently, the global financial markets have been highly volatile, with heightened risk-aversion sentiment from investors.  Both the macro-economic and financial environments are filled with risks and uncertainties.  Shocks in the financial and asset markets have been driven by factors including the uncertain outlook of the Ukraine situation, fluctuations in oil prices and persistently high inflation.  As an international financial centre and a small and open economy, Hong Kong cannot be immune.  Coupled with other factors or news relevant to the Hong Kong market, our stock market has experienced sharp fluctuations for consecutive days.

When the market is volatile, we should stay vigilant and carefully manage risks.  We need not be overly worried about the direct impact of the Ukraine situation on Hong Kong’s economy.  As exports of goods to Russia and Ukraine represented only 0.78% and 0.05% of the total in 2021 respectively, the impact on Hong Kong’s export and economic growth will be limited.  On inflation, given the expenditure weight of energy is about 3% in the local consumer price index, their effect on Hong Kong’s inflation is likely to be relatively benign even if international energy prices further increase.  Furthermore, risk exposures of the Hong Kong banking system to Russia is insignificant (only about 0.01% of the total assets of the banking sector).

Q2: Have there been abnormal movements in the Hong Kong financial markets? Will there be speculators taking the opportunity to attack Hong Kong Dollar (HKD) and stock market?

A2: Hong Kong’s financial system has a solid foundation.  Our foreign reserve is equivalent to 136% of Gross Domestic Product (GDP) and the capital ratio of the banking system is 20.4%, both having grown considerably by nearly 30% since the Global Financial Crisis in 2008, providing Hong Kong’s financial markets with strong buffers and resilience to counter market shocks triggered by external factors.  Since the worsening of the Ukraine situation, the HKD market has continued to operate in an orderly manner.  The HKD exchange rate has remained stable, and we have not seen abnormal flows of funds or signs of shorting or attacking HKD in large scale.  While the stock market has been severely fluctuating alongside other markets, trading activities have remained smooth and normal.

We have also equipped ourselves with comprehensive and detailed analysis framework as well as tools to monitor, make projection and raise alert, and are able to prevent and manage financial risks more effectively than before.  The HKMA has also been closely communicating and exchanging information with other financial regulators in monitoring cross-market situations, with a view to ensuring financial safety and stability.

The Hong Kong economy and market are facing various challenges locally and externally, which is exactly the time to let the “breakwater” that we have built up over the years to play its role.  With our solid foundation, Hong Kong has weathered many storms and adversities in the past.  The HKMA has also accumulated sufficient capacity and experience to maintain Hong Kong’s financial and monetary stability.  I urge everyone to keep up our confidence, strive to overcome the pandemic together and work hard for the early economic re-opening after the pandemic.

Q3: Will Hong Kong immediately follow the US to raise interest rates?  If not, to what level should the Aggregate Balance (AB) move downward before an increase in the HKD interest rates will be triggered? 

A3: Under the Linked Exchange Rate System (LERS), the HKD interbank rates normally track their USD counterparts, whilst also being influenced by the HKD supply and demand in the local market.  Drawing reference from experience, including that in the US’s last rate hike cycle in 2015-2018, the HKD interbank rates may not necessarily rise with the USD interest rates immediately.  Currently, there is ample liquidity in Hong Kong’s banking system.  It is expected that the HKD interbank rates might also lag the USD interest rates (especially short-term interbank rates) in this rate hike cycle.  The extent of lagging will depend on HKD supply and demand situations in the local market.  I noted some market commentaries had opined that the HKD interbank rates would rise when the AB declines to a certain level.  Although the AB is an important indicator of banking sector liquidity, whether or not the HKD interbank rates would rise is not entirely contingent on a specific level of AB because the situations and market factors in each rate hike cycle may be different.  It is not appropriate to draw a sweeping conclusion.

Q4: Will banks increase their saving and mortgage interest rates?  What would be the impacts of the US rate hike on Hong Kong’s property market?  

A4: Banks will decide whether to adjust saving and mortgage interest rates, when to adjust them and by how much having regard to their own funding cost structures and other relevant considerations.  Many residential mortgage interest rates benchmark the one-month HKD interbank rates, which recently exhibited a gradual rising trend.  As such, the public should carefully assess and manage the relevant risks when making property purchase, mortgage or relevant decisions.

It should be noted that interest rate is not the sole factor influencing the development of Hong Kong’s property market.  Other important factors include the development of the pandemic and economy, housing supply, and market sentiment.   

Q5: Will HKD touch the 7.85 weak-side Convertibility Undertaking level soon?  Is the HKMA worried about fund outflows?

A5: The LERS has continued to work well, having weathered many economic and interest rate cycles in its nearly four decades of operation.  The US’s entry to a rate hike cycle will not affect Hong Kong’s financial and monetary stability. 

Under the LERS, there will be sufficient incentives for market participants to conduct carry trades should there be considerable differences between the USD and HKD interbank rates.  The interest rate automatic adjustment mechanism under the LERS will then kick in and operate.  The HKD exchange rate has been moving within the Convertibility Zone of 7.75 to 7.85 as driven by market supply and demand, which is normal operation according to the design of the LERS.

It is difficult to accurately predict the movements of the HKD exchange rate.  The situation where the HKD exchange rate triggers the weak-side Convertibility Undertaking (CU) at 7.85 and funds flow out of the HKD market would still be consistent with the expectation and design of the LERS.  After the HKMA has bought HKD from and sold USD to banks at the weak-side CU, the AB will shrink as a result, giving the HKD interbank rates more momentum to rise and offsetting the incentives of doing carry trades.  This will reduce fund outflows from the HKD market, contributing to stabilising the HKD within the zone of 7.75 to 7.85.  We have accumulated the USD reserves over the years to provide at least 100% of support to the Monetary Base in order to ensure the smooth execution of the abovementioned process.       

I hope this article can help the public understand the impacts of the US rate hike and recent global financial environment on Hong Kong.  The HKMA will continue to closely monitor market situations with a view to maintaining stability in Hong Kong’s financial and monetary systems. 

Eddie Yue Chief Executive

Hong Kong Monetary Authority

17 March 2022