Interest Rate Adjustment Mechanism
Under the Currency Board system, the stability of the Hong Kong dollar exchange rate is maintained through an automatic interest rate adjustment mechanism. When there is a decrease in demand for Hong Kong dollar assets and the Hong Kong dollar exchange rate weakens to the convertibility rate, the HKMA stands ready to purchase Hong Kong dollars from banks, leading to a contraction of the Monetary Base. Interest rates then rise, creating the monetary conditions conducive to capital inflows so as to maintain exchange rate stability. Conversely, if there is an increase in the demand for Hong Kong dollar assets, leading to a strengthening of the exchange rate, banks may purchase Hong Kong dollars from the HKMA. The Monetary Base correspondingly expands, exerting downward pressure on interest rates and so discouraging continued inflows.