HKD peg still safe despite recent weakness – BBH
The Hong Kong dollar has steadily weakened this year, yet there is no threat at all to the peg, which we see being maintained for the foreseeable future, according to analysts at BBH.
Key Quotes
“On July 1, China and Hong Kong commemorated the 20th anniversary of the handover from the UK. It came at a time when Hong Kong is pushing for greater autonomy even as the mainland tries to exert greater control. In President Xi's anniversary speech, he warned that any threat to China's central government rule was "absolutely impermissible."
“The economy is picking up, helped by an improving mainland outlook. GDP growth is forecast by the IMF to accelerate to 2.4% in 2017 and 2.5% in 2018 from 2.0% in 2016. GDP rose 4.3% y/y in Q1, the strongest since Q2 2011. Monthly data for Q2 suggest continued strength, while 2016 provides a low base effect. As such, we see some upside risks to the growth forecasts.”
“Price pressures have stabilized, with CPI rising 1.9% y/y in June. This is down from the 4.3% y/y peak back in August 2016. The Hong Kong Monetary Authority (HKMA) does not have an explicit inflation target nor does it run an independent monetary policy due to the HKD peg to USD. Indeed, it has raised the base rate four times since December 2015, in lockstep with the Fed.”
“HKD Peg Outlook
- Under the initial peg arrangement, HKD could not trade on the weak side (above) the 7.8 peg rate, but could appreciate without limit to the strong side (below 7.8). A minor adjustment was made in May 2005, when a trading band of 7.75-7.85 was introduced around the peg rate that prevented appreciation beyond 7.75. The Hong Kong Monetary Authority (HKMA) is obliged to buy and sell USD to prevent the HKD from breaching either side of the band.
- Since the peg was put in place, it has really been tested only once, during the Asian Crisis that started in 1997. Interbank rates soared in 1998, as foreign reserves fell and the domestic money supply shrank. The HKMA also took some unorthodox steps then, such as buying Hong Kong stocks as the Hang Seng plunged. Ultimately, the HKMA prevailed then and we would expect similar success if the HKD were to come under greater pressure now.
- The HKMA runs a strict currency board. In essence, this means that every HKD in circulation is backed by an equivalent amount (at the official exchange rate) of USD. When run correctly, such a peg cannot be broken. Argentina’s peg was broken because it violated several of the basic tenets of a currency board, including central bank financing of the budget deficit.
- We continue to believe that it is realistic scenario to expect a re-pegging of the HKD to the Chinese yuan at some time in the future (perhaps in 10+ years?). It seems that if conditions merit (full yuan convertibility, continued integration of Hong Kong into mainland China), then the Chinese authorities could eventually link or perhaps even unify the Hong Kong dollar with the yuan.
- This is a long-term proposition, and there will likely be ample warnings and leaks during the process so that investors are not caught unaware. China authorities will manage market expectations in order to minimize potential turmoil and disruptions from such a game-changing move. For now, we see no change to the HKD peg.”
“USD/HKD traded yesterday at its highest level since January 2016. It appears to be on track to rest the January 2016 high near 7.83, which also happens to be the high from August 2007. As local interest rates spiked then, the pair quickly moved back below the 7.8 area. This would likely happen again if pressures on HKD intensify.”