HKMA keeps base rate at 4.25% as peg ties policy to Fed

For Hong Kong, Thursday's decision underscores that local borrowing costs remain linked to the Fed's rate trajectory, irrespective of domestic conditions. Mortgage holders and property developers face the most risk, since a December Fed increase would pass through to the base rate and then to bank lending rates. The peg also means Hong Kong dollar assets carry US interest rate exposure. When positioning for rate moves in Hong Kong, traders should monitor Fed expectations rather than the HKMA.

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Earlier:

• Recap: Fed holds at 3.75%-4% in 10-2 vote as Cook dissents for a hike, December move in focus
• investingLive Americas FX news wrap 28 Oct: Fed holds rates, yield curve steepens as Big Tech earnings diverge

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Hong Kong's interest rate decisions originate in Washington, and with a December Fed hike widely anticipated, the city's borrowers are set for the ride.

Summary:

• The HKMA kept its base rate at 4.25%, as predicted, after the Fed maintained its rate at 3.75% to 4%
• Hong Kong's Linked Exchange Rate System, operational since 1983, holds the currency between HK$7.75 and HK$7.85 per US dollar
• The base rate is determined as 50 basis points above the Fed funds range's lower bound, or a HIBOR-based average if that is greater
• The HKMA defends the band by purchasing or selling Hong Kong dollars, which influences interbank rates
• The peg means Hong Kong essentially imports US monetary policy
• A December Fed hike would likely lift Hong Kong's base rate in tandem

The Hong Kong Monetary Authority left its base rate unchanged at 4.25% on Thursday, as anticipated, after the US Federal Reserve decided to stay at 3.75% to 4%. The result was predetermined, and grasping why explains how Hong Kong conducts monetary policy.

Hong Kong has run its Linked Exchange Rate System since 1983. Under that system, the Hong Kong dollar is kept within a tight band of HK$7.75 to HK$7.85 against the US dollar. The HKMA commits to buying or selling Hong Kong dollars at either edge of that range, thereby anchoring the currency to the greenback.

A fixed exchange rate involves a trade-off: a city cannot pursue independent interest rate policy while maintaining a currency peg. If Hong Kong rates diverged significantly from US rates, capital would flow to the currency offering higher returns, pressuring the peg. Thus Hong Kong effectively adopts US monetary policy.

That connection is enshrined in the base rate formula. The rate is set at the higher of two values: 50 basis points above the lower end of the Fed funds target range, or an average of short-term Hong Kong interbank rates (HIBOR). With the Fed's range beginning at 3.75%, adding 50 basis points gives exactly 4.25%. When the Fed moves, the HKMA follows.

Market forces reinforce the formula. If the Hong Kong dollar weakens to HK$7.85, the HKMA buys local currency, removing cash from the banking system and pushing interbank rates higher until the currency recovers. At the strong end, it sells Hong Kong dollars, adding liquidity and pushing rates down.

The practical upshot is that Hong Kong's borrowing costs are dictated by conditions in the United States rather than at home. That is significant now. The Fed held this week but indicated inflation remains its priority, and markets broadly expect a hike in December. If that occurs, Hong Kong's base rate will likely rise in step, regardless of the state of its own economy.