Hong Kong Monetary Authority Intervenes to Defend Currency Peg, Sells HK$9.4 Billion

The Hong Kong Monetary Authority (HKMA) has intervened in the foreign exchange market after the Hong Kong dollar weakened to HK$7.85 per US dollar, the lowest point permitted under the region’s currency peg system. This action involved selling HK$9.4 billion, approximately $1.2 billion, from its reserves to purchase local currency, thereby tightening liquidity in the banking system and increasing interbank lending rates. Since early May, these rates had been near zero, facilitating carry trades where traders borrowed cheap Hong Kong dollars, converted them to US dollars, and profited from the interest rate differential. This intervention aims to make such trades less profitable by increasing borrowing costs.

This is the second intervention by the HKMA this year. The previous intervention occurred last month when the Hong Kong dollar strengthened, requiring the HKMA to inject local currency into the market. This action increased liquidity and lowered lending rates, making the Hong Kong dollar cheaper and widening the interest rate gap with the US dollar. The recent intervention reverses this trend by reducing liquidity and increasing borrowing costs, which will lower the city’s aggregate balance to HK$164 billion. This balance had increased during the previous intervention but is now being reduced.

The last time the HKMA had to support the local currency in this manner was in May 2023. The recent weakness of the US dollar has put pressure on the peg, making the carry trade more attractive due to the interest rate gap. The gap between one-month US and Hong Kong interest rates reached 3.4% this week, making the trade highly profitable for global players. The volatility in the Hong Kong dollar has raised concerns about the future of the peg system, with some speculating about its sustainability. However, there are no immediate signs of the peg breaking.

Following the latest intervention, the Hong Kong dollar recovered slightly, moving to HK$7.8492 per US dollar during Thursday morning trading in Asia. The HKMA aims to keep the currency within the HK$7.75-HK$7.85 band. This rigid system has been in place for decades but has faced increased volatility this year. Chief Executive John Lee Ka-chiu has reiterated the region’s commitment to maintaining the currency peg, stating that it is a key success factor. Despite market pressures, the region holds $431 billion in foreign currency reserves, providing sufficient firepower to defend the peg. The HKMA’s intervention has recalibrated trader strategies, and the Hong Kong dollar is now back within its allowed range. The sustainability of this stability remains to be seen.