(Approved for Issue by the Exchange Fund Advisory Committee on 16 November 2004)
Report on Currency Board Operations (29 September - 21 October 2004)
The Sub-Committee noted that the Hong Kong dollar had strengthened during the period under review, following a weakened US dollar and renewed talk about the renminbi exchange rate regime. Interbank interest rates had declined markedly. The Aggregate Balance, having dipped to HK$3.23 bn near to the beginning of the period, closed the period at HK$4.81 bn. Members noted that the Aggregate Balance had continued to expand after the period under review on the inflow of funds into the Hong Kong dollar, and was around HK$12.5 bn at the time of the Sub-Committee's meeting. Members also noted that, during the period under review, the Monetary Base as a whole had decreased slightly, owing to a decline in the outstanding amount of Certificates of Indebtedness for banknotes in circulation.
2. The Sub-Committee noted that, in accordance with Currency Board principles, changes in the Monetary Base during the reporting period had been fully matched by changes in the foreign reserves.
3. The report on Currency Board operations for the period under review is at Annex A.
Monitoring of Risks and Vulnerabilities
4. The Sub-Committee noted that economic growth, both in Hong Kong and worldwide, had generally slowed in the third quarter. The main exception had been the Mainland of China, where a rebound in the third quarter had prompted the People's Bank of China to increase benchmark interest rates on 28 October. Members were of the view that this measure should further help guide the economy to a soft landing, which would be conducive to monetary stability in Hong Kong. Members noted that, while the likelihood of a sharp rise in US interest rates appeared to have lessened, high oil prices had continued to contribute to volatility in financial markets.
5. The Sub-Committee noted a special analysis on inflation in Hong Kong, against the background of recent increases in headline inflation, strong economic growth, rising property markets and an improving labour market, and a pick-up in global, and especially Mainland, inflation. The analysis found that, while prices were expected to continue to rise in 2005, the risk of a sharp acceleration in inflation was low.
HKMA Operations in the Foreign Exchange Market: September 2003- September 2004
6. The Sub-Committee considered a paper that reported on the pattern of foreign exchange market operations by the HKMA over the past year, a period the first half of which had seen a marked strengthening of the Hong Kong dollar. The analysis examined the causes of the strengthening and the reasons behind the slow return of the Hong Kong dollar to the Convertibility Undertaking rate of 7.8. The analysis found that, while domestic factors played a role, the strong inflows in September 2003 were mainly associated with a weakening of the US dollar and market speculation about a renminbi revaluation. The reasons for the slow return to the Convertibility Undertaking rate were, first, the time needed by some investors to unwind large short Hong Kong dollar positions; and, secondly, the limited interest rate differential, despite the sharp increase in the Aggregate Balance, reflecting low short-term US interest rates at around one per cent and the fact that Hong Kong dollar rates cannot fall below zero.
7. Members observed that the operations carried out by the HKMA in response to the strengthening of the Hong Kong dollar in September 2003, and subsequently, had been consistent with Currency Board principles and appropriate given that, in the absence of an explicit convertibility undertaking on the strong side, the HKMA had some limited technical discretion in determining at what level and in what circumstances it accepted offers from banks to purchase US dollars.
A Graphical Framework for Monitoring Property Market Developments in Hong Kong
8. Members considered a paper that presented a graphical framework for monitoring property market conditions and vulnerabilities in Hong Kong. The paper presented the evolution of five key indicators (property prices, property transaction volumes, new mortgages, the income-gearing ratio, and the buy-rent gap, which measures the funding cost of buying a property relative to its rental yield) in the form of a pentagon, to compare the current situation with the boom and bust cycles of the past decade or so. The analysis using this framework suggested that the risk of a property bubble was currently low, despite the sharp rebound in prices since the summer of 2003.
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Kevin Ip, Manager (Press), at 2878 1687 or
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Hong Kong Monetary Authority
26 November 2004
