Record of Discussion of the Meeting of the Exchange Fund Advisory Committee Currency Board Sub-Committee held on 20 June 2008

(Approved for Issue by the Exchange Fund Advisory Committee by circulation on 18 July 2008)

Report on Currency Board Operations (6 May - 5 June 2008)

The Sub-Committee noted that the Hong Kong dollar exchange rate had softened during the reporting period. Interbank interest rates had increased and their negative spreads against US dollar interest rates had narrowed. The Monetary Base had decreased slightly from HK$325.85 billion to HK$324.62 billion.

2. The Sub-Committee noted that, in accordance with Currency Board Principles, changes in the Monetary Base had been fully matched by corresponding changes in 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 global financial markets had shown further signs of stabilisation in May. Credit spreads had not risen sharply. Most central banks had kept their policy interest rates unchanged in May. Financial markets generally expected the US Federal Reserve to cease further monetary easing at the June FOMC meeting.

5. The outlook for the US economy remained weak, although GDP estimates for the first quarter still showed positive growth. Headline inflation remained elevated. Poor credit-market conditions and prolonged weakness in the housing market were major factors hindering the recovery of the US economy.

6. The Sub-Committee noted that rising global inflation had become a major concern, particularly in emerging-market economies. If inflation continued to rise, a deterioration of investor sentiment about these economies could not be ruled out, although improvements in economic fundamentals in Asia since the Asian financial crisis had made the region less vulnerable to exogenous shocks.

7. The Hong Kong economy had grown strongly by 7.1% year on year in the first quarter. Despite the global economic slowdown, overall export performance had been more resilient than expected thanks to robust expansion of intra-regional trade and strong import demand from the Mainland. Both headline and underlying inflation had risen to 5.4% in April, driven by rising food prices and housing rents.

8. The Sub-Committee noted an analysis which concluded that the oil intensity of the Hong Kong economy had remained stable at a relatively low level in the past decade. The analysis suggested that the direct impact of rising oil process on Hong Kong's output and inflation, although not negligible, was relatively small.

Rising Food Prices in Asia and Implications for Monetary Policy

9. The Sub-Committee noted a paper analysing the effects of rising food prices in Asia and their implications for monetary policy. The study suggested that, given its high visibility, food price inflation might have second-round effects on general consumer price inflation via higher inflation expectations in developing Asian economies. Such a risk warranted close monitoring.

Impact of IPO Activities on the Hong Kong Dollar Interbank Market

10. The Sub-Committee noted a study of the effects on the interbank market of the large fund-raising activities for initial public offerings (IPO) in the Hong Kong stock market. The study found that, during the period under study (2005-2007), funding needs on the closing date of IPOs increased the level and volatility of the overnight and one-week HIBORS, but not those of longer-term HIBORS.

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Hong Kong Monetary Authority
25 July 2008