For Hong Kong, the decision confirms that local borrowing costs stay tied to the Fed’s hiking path, regardless of domestic conditions. Mortgage holders and property developers are most exposed, because a December Fed hike would flow through to the base rate and from there to bank lending rates. The peg also means Hong Kong dollar assets carry US rate risk. Traders should watch Fed expectations, not the HKMA, when positioning for Hong Kong rate moves.

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Earlier:

• Recap: Fed holds at 3.75%-4% in 10-2 vote as Cook dissents for a hike, December move in focus
• investingLive Americas FX news wrap 28 Oct: Fed holds rates, yield curve steepens as Big Tech earnings diverge

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Hong Kong’s rate decisions are made in Washington, and with a December Fed hike widely expected, the city’s borrowers are along for the ride.

Summary:

• The HKMA held its base rate at 4.25%, as expected, after the Fed held at 3.75% to 4%
• Hong Kong’s Linked Exchange Rate System, in place since 1983, keeps the currency between HK$7.75 and HK$7.85 per US dollar
• The base rate is set at 50 basis points above the lower end of the Fed funds range, or a HIBOR-based average if that is higher
• The HKMA defends the band by buying or selling Hong Kong dollars, which moves interbank rates
• The peg means Hong Kong effectively imports US monetary policy
• A December Fed hike would be expected to lift Hong Kong’s base rate in step

The Hong Kong Monetary Authority kept its base rate unchanged at 4.25% on Thursday, as expected, following the US Federal Reserve’s decision to hold its policy rate at 3.75% to 4%. The outcome was never in doubt, and understanding why explains how Hong Kong runs monetary policy.

Hong Kong has operated its Linked Exchange Rate System since 1983. Under it, the Hong Kong dollar is held within a narrow band of HK$7.75 to HK$7.85 against the US dollar. The HKMA commits to buy or sell Hong Kong dollars at either edge of that range, which keeps the currency anchored to the greenback. 

A fixed exchange rate comes with a trade-off: a city cannot run an independent interest rate policy while keeping its currency pegged. If Hong Kong rates drifted far from US rates, capital would flow toward whichever currency paid more, putting pressure on the peg. So Hong Kong effectively imports US monetary policy.

That link is written directly into the base rate formula. The rate is set at the higher of two measures: 50 basis points above the lower end of the Fed funds target range, or an average of short-term Hong Kong interbank rates, known as HIBOR. With the Fed’s range starting at 3.75%, adding 50 basis points produces exactly 4.25%. When the Fed moves, the HKMA follows.

Market forces back up the formula. If the Hong Kong dollar weakens to HK$7.85, the HKMA buys local currency, draining cash from the banking system and pushing interbank rates higher until the currency recovers. At the strong end, it sells Hong Kong dollars, adding liquidity and pushing rates down.

The practical consequence is that Hong Kong’s borrowing costs are set by conditions in the United States rather than at home. That matters now. The Fed held this week but signalled that inflation remains its priority, and markets widely expect a hike in December. If that happens, Hong Kong’s base rate is likely to rise in step, whatever the state of its own economy. 

This article was written by Eamonn Sheridan at investinglive.com.

Source: Investing Live - Central Bank