US rate hike comes at worst time for Hong Kong

posted on Sunday, May 15, 2022 at 12:29 pm.

The tightening of monetary policy in the United States comes at a worst time for Hong Kong, which, with its currency pegged to the dollar, is forced to follow the move despite a struggling economy.

This near-fixed exchange rate of the Hong Kong dollar against the US dollar, introduced in 1983, enabled the Territory to overcome the 1997 Asian financial crisis and solidify its status as a major global financial center.

But it also means that Hong Kong has no choice but to go along with the monetary policy of the US Federal Reserve, which just implemented the biggest rate hike in 22 years in an attempt to curb inflation.

“The Covid outbreak in Hong Kong and mainland China is already hurting growth,” said Lloyd Chan, an economist at Oxford Economics. “The last thing Hong Kong needs right now is an interest rate hike.”

On Friday, the territory revised its growth forecast for 2022, now expected to be between 1% and 2%, after falling 4% in the first quarter, much worse than expected.

After more than a decade of low interest rates, Hong Kong is facing a backlash, the city’s chief financial officer, Paul Chan, warned last week.

“While the economy has not yet fully recovered from the epidemic, we must remain vigilant about the impact of interest rate increases (…) on the population and small and medium-sized businesses,” Mr. Chan wrote on his official website.

Until now, Hong Kong banks have struggled to keep the stable rates reserved for their best clients. But analysts estimate they will be taken by the throat within three to six months.

“Interest rates could rise faster than in the past given the accelerated pace being followed by the Fed, as well as the general shift in risk perception around the world,” said Gary Ng, an economist at Natixis.

– Properties on the first line –

Holders of mortgages pegged to Hong Kong’s HIBOR rate will be the first to be hit by the shock, Moody’s economist Heron Lim predicts. This will lead to lower property prices in 2022 and 2023, he said, “especially if demand from mainland Chinese investors is weak.”

Higher mortgage prices should also put pressure on household portfolios, slow their consumption and therefore delay the recovery of Hong Kong, whose economy slowed in the first quarter due to draconian restrictions against Covid-19.

SMEs are also facing “very hard times” if rate hikes are accompanied by an epidemic rebound, fears Samuel Tse, an economist at DBS Bank.

The Hong Kong currency can fluctuate between 7.75 and 7.85 Hong Kong dollars per US dollar. The exchange rate is currently at the lower end of this range due to capital flight.

Last week, the Hong Kong Monetary Authority (HKMA) spent HK$8.53 billion ($1.08 billion) to support the local currency, its first intervention since 2019.

Some commentators have begun to question the merits of the dollar peg, citing pandemic-related pressures and tensions between China and the US. This styling is a “very reliable and transparent” system, defended the deputy head of the HKMA Edmond Lau.

Four analysts polled by AFP agree that Hong Kong will maintain its dollar peg despite changes in the global economy.

“Even though foreign exchange reserves have fallen from $500 billion to about $460 billion, this is still a relatively high level that should be enough to protect the Hong Kong dollar,” DBS’s Tse said.

According to Moody’s Mr Lim, the current system is “very justified” as long as Hong Kong remains an international gateway to the Chinese economy.

Meanwhile, Nataxis’ Ng notes that no panic selling has hit the Hong Kong dollar so far, which he says bodes well for the future of the peg. “But in the medium or long term,” he adds, referring to the divergence between the Chinese and US economies, “it will depend on whether the benefits of this monetary stability outweigh the costs.”