A measure of Hong Kong's interbank liquidity halved in the past 2 months, with analysts forecasting more cash drainage as the city's de-facto central bank defends its currency.

The Hong Kong Monetary Authority (HKMA) has bought a total HK$172 billion (S$30.3 billion) of local currency since May 11, shrinking the aggregate balance to about HK$165 billion. That has pushed up local interest rates, helping narrow the gap with the US to help the HKMA maintain its dollar peg.

The intervention though is draining the city's liquidity, with Hayman Capital Management's Kyle Bass claiming it may be depleted by the end of next month. That's prompted the monetary authority to vehemently defend its currency policy last week. The Hong Kong dollar is set to come under renewed weakening pressure with the Federal Reserve forecast to raise its key interest rate by another 75 basis points on Wednesday (Jul 27).

The HKMA's liquidity withdrawals have pushed the 1-month Hong Kong interbank offered rate up by 32 basis points this month to 1.19 per cent, the highest level since April 2020. That's helped narrow the spread with the London interbank offered rate of the same tenor, but the gap between the 2 remains over 100 basis points, making it attractive for traders to short the local currency versus the US dollar.

"It appears that the aggregate balance will fall to below HK$100 billion after the Fed meeting in September," said Ken Cheung, chief Asian foreign-exchange strategist at Mizuho Bank in Hong Kong. Hibor will catch up with its US equivalent at year-end, he said.

The Hong Kong dollar was at 7.8488 to the US dollar at 12.42 pm local time on Tuesday, near the weak end of its 7.75-to-7.85 allowed trading range.

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"If the 1-month Libor-Hibor spread narrows and is sustained at a level below 50 basis points, there may be some relief for the local currency," said Carie Li,  global market strategist at DBS (Hong Kong). Libor isn't likely to peak until the end of the Fed rate-hike cycle, she said.

HKMA officials have expressed confidence in the currency peg even as rising borrowing costs hurt local property developers that are already under pressure from an exodus of Hong Kong residents and a Covid-led contraction of the economy.

While there's been a slight correction in Hong Kong property prices in the past few months, they have generally remained stable, Financial Secretary Paul Chan wrote in a blog post on Sunday. Hong Kong's "huge" foreign-exchange reserves, about US$440 billion, are enough to maintain the linked-exchange-rate system even as rising US interest rates lead to capital outflows, he said.

The HKMA on Friday said the city's currency peg has "worked well" for nearly 40 years, and there are no plans to change it, according to a statement issued in the name of chief executive Eddie Yue. BLOOMBERG