Record of Discussion of the Meeting of the Exchange Fund Advisory Committee Sub-Committee on Currency Board Operations held on 9 July 2004

(Approved for Issue by the Exchange Fund Advisory Committee on 29 July 2004)

Report on Currency Board Operations (29 May - 23 June 2004)

The Sub-Committee noted that the Hong Kong dollar exchange rate had eased during the reporting period, reflecting in part the strengthening of the US dollar. Hong Kong dollar interbank interest rates had firmed, reflecting expectations of higher US rates, but they had remained below their US dollar counterparts.

Members observed that, subsequent to the period under review, the Fed funds target rate of the US had increased by 0.25 percentage point. Although, in accordance with the Currency Board arrangements, the Base Rate had been increased by the same magnitude, banks in Hong Kong had generally not so far seen a need to increase Hong Kong dollar interest rates because of the large amount of liquidity remaining in the interbank market.

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.

The report on Currency Board operations for the period under review is at Annex A.

Monitoring of Risks and Vulnerabilities

The Sub-Committee noted that there had in recent months been robust growth in the US, Japan and Asian economies. In Mainland China, however, there appeared to be early signs of a policy-induced slowdown. Economic developments in Hong Kong continued to be encouraging, with a generally positive near-term outlook. This was attributable both to the strong global recovery and to a marked revival in the local property market and in domestic consumption. Three main concerns presented possible risks to this outlook: these were the possibility of larger and faster-than-expected US interest rate increases; the possibility of a sharp slowdown in the Mainland economy; and possible higher oil prices.

Macroeconomic Conditions in Mainland China

The Sub-Committee noted a paper summarising current macroeconomic conditions in Mainland China and examining some issues of concern and the measures taken to address them. Among the concerns were the recent rapid expansion in fixed asset investment and bank credit; and rising inflation. Members noted signs that the tightening measures taken so far by the Mainland authorities had helped bring down growth in fixed asset investment and bank credit considerably, although headline inflation had continued to rise.

Using the Federal Funds Futures Rate to Extract Information on Market Expectations of US Monetary Policy

Noting the importance of monetary policy actions for Hong Kong under the Linked Exchange Rate system, the Sub-Committee considered an information paper on issues arising from the common practice of extracting information on market expectation from US Federal Funds Futures Rates. Straightforward readings of the pricing of Fed Funds Futures could be misleading because of the presence of risk premia and persistent errors in market expectation: these difficulties were particularly pronounced during turns of the interest rate and business cycles. The paper examined how more meaningful market expectation of future US policy actions could be extracted from Fed Funds Futures by using business cycle indicators.

For further enquiries, please contact:
Kevin Ip, Manager (Press), at 2878 1687 or
Thomas Chan, Senior Manager (Press), at 2878 1480

Hong Kong Monetary Authority
30 July 2004