Signage for the Hong Kong Monetary Authority (HKMA) is displayed outside Two International Finance Centre (IFC) in the business district of Central in Hong Kong. Photographer: Jerome Favre/Bloomberg

Hong Kong money market rates jump as c.bank soaks up cash

Hong Kong (Reuters) – Hong Kong’s money market rates spiked this week to multi-year highs, reacting afresh to the central bank’s efforts in the past few months to soak up excess cash, push rates closer to U.S. yields and put a floor under its currency.

Three-month interbank rates have climbed 22 basis points in three weeks to 0.985 per cent, their highest since early February, which is a rare move in a market whose currency is loosely pegged to the U.S. dollar and whose interest rates shadow U.S. yields.

Market participants said cash supplies had tightened after a spurt in initial public offerings of shares by companies in the past couple of months along with a sudden increase in issuance of bills by the de facto central bank, the Hong Kong Monetary Authority (HKMA).

It appeared the HKMA was trying to soak up the excess cash in the banking system so that domestic rates would re-align more closely with rising U.S. yields, analysts said.

“It is probably a precautionary measure as low HIBORs may lead to complacency in the markets and also stoke speculation in the Hong Kong dollar,” said Eugene Leow, a strategist with DBS Bank in Singapore.

“The bill issuances are part of their open market operations. More issuances will help tighten liquidity and lift HIBORs closer to LIBORs.”

HIBOR-LIBOR spreads, the differential between floating rates at which banks lend to each other in Hong Kong and the U.S. respectively, had been gradually widening since the beginning of the year as markets priced in a steady rise in U.S. interest rates. The spread was 2 basis points at the beginning of the year, moved to as wide as 81 basis points at the end of August and is now half that level.

The HKMA issued HK$80 billion (US$10.3 billion) worth of Exchange Fund Bills (EFBs) since early August, helping push up HIBOR. On both occasions when it announced the issuance of the bills, the HKMA said the issuance had nothing to do with the Hong Kong dollar’s weakening since the beginning of this year.

The Hong Kong dollar is pegged at 7.8 to the U.S. dollar, but can trade between 7.75 and 7.85. The HKMA is obliged to intervene when the Hong Kong dollar hits either end of the band to keep it intact.

Flush liquidity in the economy had driven the Hong Kong dollar down by nearly 1 per cent between January and early September, close to the weak end of its band. It has since recovered to around 7.8 per U.S. dollar.

Alongside the rise in HIBOR, the sum of balances maintained by commercial banks with the Hong Kong central bank, or the ‘aggregate balance’, has fallen from about HK$259.57 billion in the last week of August to HK$179.73 billion by the end of October.

“The issuance of additional EFBs and tightened liquidity is providing support to the Honky,” said Gao Qi, an FX strategist at Scotiabank in Singapore, referring to the currency by its nickname.

“The currency had depreciated a lot since the beginning of the year, so it is a correction and could be attributed to tightened Hong Kong dollar liquidity conditions.”

Traders said the currency seemed to have stabilised in the middle of the band. They had expected the HKMA to issue more bills last week, but the central bank did not do so.

Yet, they also expect the HKMA to keep a close eye on HIBOR and ensure it doesn’t lag U.S. rates.

“Low rates may lead to asset bubbles being built as investors get complacent,” said Leow of DBS Bank. “This could prove problematic in an environment where the G10 economies are tightening policy.”

by Rushil Dutta