HONG KONG -- The Hong Kong dollar's sharp fall reveals how the currency's peg to the U.S. dollar is colliding with the territory's deepening integration with the Chinese mainland economy.
In London, the Hong Kong dollar traded for 7.85 against the greenback at one point Thursday, its weakest level in roughly 35 years. Hong Kong started pegging its currency to the dollar in 1983, and in 2005 introduced the trading band allowing the currency to move between 7.75 and 7.85.
The Hong Kong Monetary Authority, the city's de facto central bank, intervenes to defend the peg if the currency touches either side of the trading band. The authority propped up the currency by purchasing HK$816 million from the market Thursday, eventually buying a sum of HK$3.26 billion over two days through Friday.
This was the first time the monetary authority stepped in to maintain the band on the weak end since the peg came into place.
Standing behind the softening Hong Kong dollar is the growing interest rate gap between the former British colony and the U.S. The Hong Kong Monetary Authority has lifted its policy rate in tandem with the U.S. But market rates in Hong Kong have barely budged because the city has attracted mainland investors and is flooded with capital.
And the low interest rates invite a carry trade in which speculators borrow cheap Hong Kong dollars and invest in higher-yielding U.S. dollar-denominated financial products.
The sale of the Hong Kong dollar for the greenback will likely continue for the time being, but Hong Kong's financial guardians are convinced they have the tools to fight back against the depreciation. The city maintains hefty foreign currency reserves, so there is no shortage of ammo to prop up the Hong Kong dollar.
The Hong Kong Monetary Authority "is fully capable of maintaining the stability of the [Hong Kong dollar] and managing large scale capital flows," Norman Chan, chief executive of the agency, said Thursday in a release. "There is no need to be concerned."
The financial markets are speculating that Hong Kong will likely adopt an even tighter monetary policy, aiming to narrow the rate gap with the U.S. and ease the pressure to sell Hong Kong dollars. Hong Kong's interbank market rate climbed steeply Friday.
Higher rates would make borrowing more expensive. That could deal a blow to the real estate market, which has been underpinned by the heavy flow of investor money. Howard Lee, deputy chief executive of the HKMA, warned borrowers to "take care" in managing interest rate payments.
It is unclear whether Hong Kong will be able to maintain the currency peg to the U.S. dollar for the long term. On the economic front, the territory will become increasingly dependent on the mainland. In terms of money flows and the economy, China's influence is growing at a stronger pace than that of the U.S.
Lee said Friday that there are no plans to alter the current monetary arrangement, citing the lack of conditions on the ground for pegging the Hong Kong dollar to the yuan. Still, it will become only harder to maintain the system as is.