Hong Kong currency intervention seen intensifying this month

[HONG KONG] The Hong Kong Monetary Authority could be even busier with currency buying in September.

The city's de facto central bank, which spent HK$33.1 billion (S$5.8 billion) last month as the Hong Kong dollar fell to the weak end of its trading band, will likely continue making purchases, according to analysts. That's because the Federal Reserve will probably raise rates in September, drawing funds out of Hong Kong and keeping the local dollar weak.

Lower interest rates relative to the greenback have made shorting the Hong Kong dollar a lucrative trade. The HKMA needs to buy the currency at the weak end of its trading band at 7.85 a dollar to defend the peg with the greenback. It did that in April, May and again last month.

"August was probably just a rehearsal, given the absence of dollar strength," said Alan Yip, Hong Kong-based senior foreign currency market strategist at Bank of East Asia Ltd. "The HKMA is highly likely to drain liquidity at a faster pace in September as outflows will intensify along with a potential Fed hike."

Continued intervention will tighten liquidity, which means borrowing costs in Hong Kong will rise. The HKMA's defense of its currency peg has already lowered the aggregate balance, a measure of interbank liquidity, to HK$76.4 billion.

"Hong Kong's aggregate balance may drop below a red line of HK$50 billion as soon as the end of September," Mr Yip said. "That will hurt market sentiment and raise concern of a dramatic surge in funding costs, reminding investors of the Asian Financial Crisis in 1998, when property prices and stock markets collapsed."

Liquidity is also likely to be pressured by demand for seasonal funding by banks and corporations, and the potential for big stock offerings in the second half of September, said Eddie Cheung, Asia foreign-exchange strategist at Standard Chartered Plc in Hong Kong.

Meituan Dianping, the Chinese restaurant review and delivery firm, has started gauging investor demand for a planned initial public offering in Hong Kong, people with knowledge of the matter said. Hotpot chain Haidilao International also kicked off so-called investor education Monday for a share sale.

Short-term Hong Kong dollar borrowing costs are rising, with the overnight rate climbing above 1 per cent on Friday for the first time since July 5.

The falling aggregate balance could spur the HKMA to add funds to the liquidity pool so it can continue intervening in the currency market, said Frances Cheung, head of macro strategy for Asia at Westpac Banking Corp in Singapore. "The HKMA may actively buy back Exchange Fund Bills or simply not to roll them over upon maturity. That would shift liquidity to the interbank market, without increasing the monetary base," she said. An HKMA spokesperson said in an email to Bloomberg that the monetary authority is "fully capable" of maintaining stability in the exchange rate and managing large capital flows. "The HKMA also stands ready to calibrate the issuance of Exchange Fund Bills to release liquidity in order to deal with possible sharp outflow from the HKD," the spokesperson said.

Outstanding EFBs stood at HK$1 trillion at the end of June. The Hong Kong dollar was little changed at HK$7.8493 per dollar as of 10.23 am local time Monday.

BLOOMBERG