Hong Kong peg to draw support even as Fed raises, says Greenwood

[HONG KONG] The Hong Kong government's support for the city's currency peg is unlikely to wane even as tightening monetary policy hits property prices, according to the architect of the exchange-rate system.

"We have very strong asset markets, and that makes it much more difficult for lower-income people to acquire property," John Greenwood, chief economist at Invesco Asset Management in London, said in a Sept 23 phone interview. "If there's a 10 to 15 per cent correction in the asset market because of a strong US dollar or rising interest rates, I think on the whole the government would welcome that." Mr Greenwood's comments come after bets on an end to Hong Kong's peg jumped to a decade-high in August in the options market as China's surprise yuan devaluation triggered depreciation across the region. Conversion from yuan assets spurred demand for Hong Kong's dollar, forcing the city's monetary authority to buy more than US$6 billion in September to prevent the currency from rising beyond the HK$7.75 upper limit of its peg against the greenback.

A linked exchange rate means the city's interest-rate policy is dictated by the Federal Reserve's. While the US central bank refrained from raising borrowing costs this month, Chair Janet Yellen said Thursday that an increase is likely this year. Higher US borrowing costs would put downward pressure on Hong Kong property prices, which are already feeling the effects of a Chinese economy expanding at the slowest pace in 25 years.

Property analysts including JPMorgan Chase & Co's Cusson Leung and Morgan Stanley's Praveen K. Choudhary estimate prices could drop as much as 10 percent next year. BNP Paribas SA said real-estate price declines will fuel public discontent toward the peg. Hong Kong's property costs are among the highest in the world, with the Centa-City Leading Index of real-estate prices surging 65 per cent since the end of 2010.

Mr Greenwood, who formulated the peg when it was introduced in 1983, predicts it will be many years before the yuan can replace the greenback in the link. Even achieving reserve-currency status at the International Monetary Fund won't lead to a change, he said.

While China has accelerated the opening up of its capital markets, many restrictions remain. The State Administration of Foreign Exchange, which has approved 132 local institutions to put as much as US$89.99 billion in offshore assets via its Qualified Domestic Institutional Investor programme, hasn't granted new allocations since March.

"It's an operational matter - whether or not banks and other operators in the capital market can freely move their funds back and forth," said Mr Greenwood. "There's no question that the Hong Kong financial market is closely integrated, on the basis of interest rates, with the US market. We would need that kind of relationship with the yuan market in order to have a valid reason for shifting the US dollar pegging arrangement to a yuan pegging. I think that's several years, indeed many years, away at the moment."

BLOOMBERG