Recently the Hong Kong dollar (HKD) exchange rate and interbank rates saw noticeable movements. There are a few underlying reasons, including the structure of the HKD market and some capital market activities. I would like to share some analyses in this regard.
Under the Linked Exchange Rate System (LERS), the HKD interbank rates usually track their US dollar (USD) counterparts, but they may also be influenced by changes in supply and demand of HKD funding in the local market, including some seasonal factors, large initial public offerings (IPOs), etc. This is what we have seen in the past few weeks. One might wonder why these movements are becoming more frequent and pronounced, given that these changes in supply and demand were not something new. Let me briefly explain.
If we take a look at past data, volatility in HKD interbank rates is quite common indeed. When there were large IPOs in the past few years, HKD interbank rates usually rose as a result of transient surge in demand for HKD funding. For example, the highly popular IPO of China Literature in 2017 locked up several hundred billion dollars during the IPO period. On that occasion, the overnight interbank rate rose by more than two percentage points from the pre-IPO level. So an increase in interbank rates in response to different market factors should be reasonably expected. It is true that the reduction of the Aggregate Balance from over HK$200 billion a couple of years ago to the current level of HK$54 billion has probably made the HKD interbank rates more sensitive to changes in supply and demand of HKD funding. But that does not mean that the current Aggregate Balance level is insufficient for meeting the settlement needs in the interbank market. It is just that banks now need to be more active in managing their day-to-day funding position so as to ensure effective deployment of liquidity for themselves and efficient circulation of liquidity in the banking system. In the past few months the HKMA has been urging banks to strengthen their liquidity management arrangements, and we are seeing banks getting prepared earlier for events like quarter-ends and IPOs. This is a normal adjustment process.
Movements in interbank rates caused by changes in funding demand can also affect the HKD exchange rate. For example, recent increases in HKD interbank rates have made carry trades of selling HKD for USD no longer profitable, so these once active carry trades have become much more subdued. When other HKD demands arose, the HKD exchange rate strengthened from 7.84 levels in early June to 7.78-7.80 a couple of weeks ago. As a result, some investors who had previously held short HKD positions via forward and option contracts decided to square their positions. In the past few days, the funding demand for a large IPO subsided, and the interbank rates began to ease and the HKD slightly softened to the current 7.82 level. The interaction between HKD interbank rates and exchange rate actually illustrates the effective functioning of the LERS, and the public needs not be concerned by occasional volatility in the HKD interbank rates and exchange rate. Our banking system remains robust and its deposit and liquidity levels continue to be stable.
Furthermore, should there be short-term liquidity tightness in the banking system due to large-scale capital market activities, banks can also make use of the HKMA’s liquidity support facilities. They may pledge their Exchange Fund Bills and Notes to obtain overnight funding through the Discount Window, or conduct foreign exchange swap or term repo transactions with the HKMA to get HKD liquidity.
As an international financial centre, Hong Kong thrives on an active capital market with a variety of financial activities. Being a freely exchanged currency, HKD plays an important role in supporting our financial market development. The HKMA will continue to take appropriate measures to ensure effective operation of the HKD market in accordance with the LERS, and to ensure monetary and financial stability in Hong Kong.
Deputy Chief Executive
Hong Kong Monetary Authority
15 July 2019