Record of Discussion of the Meeting of the Exchange Fund Advisory Committee Currency Board Sub-Committee held on 21 October 2010

(Approved for Issue by the Exchange Fund Advisory Committee on 25 November 2010)

Report on Currency Board Operations (9 July 2010 - 4 October 2010)

The Sub-Committee noted that the Hong Kong dollar exchange rate had strengthened from 7.7840 to 7.7599 in the reporting period, reflecting the weakening of the US dollar and the increased demand for the Hong Kong dollar associated with fund raising activities in the equity market. The Hong Kong dollar interbank interest rates had declined, tracking decreases in their US dollar counterparts.

2. The Sub-Committee noted that the Monetary Base had remained steady at around HK$1,030 billion during the period under review.

3. 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.

4. The Report on Currency Board Operations for the period under review is at Annex.

Monitoring of Risks and Vulnerabilities

5. The Sub-Committee noted that the slowdown in global economic activities in the major advanced economies had become more visible in the third quarter of 2010. The Sub-Committee noted the market concerns about the effectiveness of further quantitative easing by the Federal Reserve and the potential impact on monetary or financial stability. Sovereign debt problems in some European countries had also remained a lingering concern for the global economic outlook. In Mainland China, the recent policy rate hike was a positive move to reduce inflationary and property price pressure, but upside risks remain.

6. In Hong Kong, economic activity had continued to hold up well while inflationary pressure had remained in check. However, risks to financial stability had continued to rise. The Sub-Committee noted the policy measures introduced by the Government and the HKMA in August to guard against housing market risks and safeguard banking stability, and considered it too early to determine whether further policy actions were needed.

The Real Exchange Rate of the Hong Kong Dollar: Developments and Prospects

7. The Sub-Committee noted a paper concluding that the real effective exchange rate of the Hong Kong dollar had been broadly in line with its equilibrium level suggested by medium-term economic fundamentals but the risk of a potential overvaluation had emerged in view of the rising property prices and increasing inflation gap between Hong Kong and its trading partners.

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Hong Kong Monetary Authority
2 December 2010