Norman T.L. Chan, Chief Executive, Hong Kong Monetary Authority
- The FOMC decided last night to raise the Fed funds target rate by 25 basis points. This morning, the HKMA also raised the Base Rate of the Discount Window by 25 basis points to 1.00%.
- While the Fed’s move to raise rate yesterday was widely anticipated, the market focus has shifted to the pace of US monetary policy normalisation going forward. Although the Fed anticipated a gradual path of increases in the federal funds rate in the next three years, I believe we should pay attention to the following three factors influencing the US inflation and interest rate movements:
i. The US labor market continued to strengthen, with unemployment rate in November declining to 4.6%, the lowest level in more than nine years. In the period ahead, the upward pressure on wages in the US might become more pronounced, which may translate into upward pressure on consumer prices;
ii. Recently energy and commodity prices have stabilized and appeared to trend higher. This would exert rising pressure on consumer prices and inflation in the US.
iii. The incoming US administration announced plans to cut tax and increase infrastructure spending. In the short run, the expectation of such policy changes may stimulate consumption and boost economic growth.
- It is noticed that the 10-year US Treasury yields rose from a low of 1.36% in July to 1.83% before the US election, and have risen after the US election to a high of 2.57% recently. This reflects a shift in US inflation expectations in the market.
- The pace of US monetary policy normalization is set to have some impacts on capital flows, exchange rates and asset prices in the global market. Under the Linked Exchange Rate System, Hong Kong has experienced a strong capital inflow since 2008, which amounts to over US$130 billion. The Monetary Base has expanded substantially to HK$1.6 trillion, which has provided the banking sector in Hong Kong with ample liquidity and drove the interbank interest rates to very low levels. Nonetheless, one would notice that the 1-month HIBOR had already increased from a low of 0.24% in early September to 0.66% yesterday. If the USD interest rates continue to rise in the future, the interest rate differentials between the USD and the HKD will widen, and at some stage the widened interest rate differentials will lead to selling HKD/buying USD flows and the HKD exchange rate will ease and consequently reach the weak-side Convertibility Undertaking rate of 7.8500. The Monetary Base will shrink gradually as a result, leading to increases in HKD interbank interest rates. However, the rising trend in the HKD interbank interest rates is likely to be gradual, depending on the scale of outflows from HKD, international developments and other related factors. It will be difficult to forecast precisely the pace of increases in HKD interest rates in the wake of considerable uncertainties over the path of US monetary policy normalization.
- I would like to remind the pubic to stay vigilant and prepare for the market volatility and risk that may arise from the normalisation of USD and HKD interest rates going forward.