Hong Kong’s Linked Exchange Rate System is a Currency Board system with the following features:
Under the Currency Board system,
- The Monetary Base is fully backed by foreign reserves, and all changes in the Monetary Base are fully matched by corresponding changes in foreign reserves held in the Exchange Fund at a fixed exchange rate.
- The HKMA provides Convertibility Undertakings (CUs), under which the HKMA commits to sell Hong Kong dollars upon request by banks at the strong-side CU of HK$7.75 per US dollar, and to buy Hong Kong dollars upon request by banks at the weak-side CU of HK$7.85 per US dollar.
The stability of the Hong Kong dollar exchange rate is maintained through an automatic interest rate adjustment mechanism and the firm commitment by the HKMA to honour the CUs.
- Inflows into Hong Kong dollars: When the demand for Hong Kong dollars is greater than the supply and the market exchange rate strengthens to the strong-side CU of HK$7.75 to one US dollar, the HKMA stands ready to sell Hong Kong dollars to banks for US dollars. The Aggregate Balance (a component of the Monetary Base) will then expand to push down Hong Kong dollar interest rates, creating monetary conditions that move the Hong Kong dollar away from the strong-side limit to within the Convertibility Zone of 7.75 to 7.85.
- Outflows from Hong Kong dollars: If the supply of Hong Kong dollars is greater than demand and the market exchange rate weakens to the weak-side CU of HK$7.85 to one US dollar, the HKMA stands ready to buy Hong Kong dollars from banks. The Aggregate Balance (a component of the Monetary Base) will then contract to drive Hong Kong dollar interest rates up, pushing the Hong Kong dollar away from the weak-side limit to stay within the Convertibility Zone.