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Hong Kong (AFP) – The Federal Reserve’s recent rate hikes have come at a bad time for Hong Kong which, thanks to its peg to the US dollar, must follow suit despite its own flagging economy.

Hong Kong has pegged its currency to the US dollar since 1983, which has helped the city weather economic storms such as the 1997 Asian financial crisis and cemented its status as a global financial hub.

But it also means Hong Kong has no choice but to follow the Fed’s latest round of hawkish rate hikes – the biggest of their kind in 22 years.

“The Covid outbreak in Hong Kong and mainland China is already hurting growth,” Oxford Economics senior economist Lloyd Chan told AFP.

“The last thing Hong Kong needs now is an interest rate hike.”

The city on Friday revised its 2022 GDP growth forecast to between 1% and 2%, after a worse-than-expected 4% drop in the first quarter.

The low interest rates that Hong Kong enjoyed for more than a decade are now facing a reversal, the city’s finance secretary says ISAAC LAWRENCE AFP

Finance Secretary Paul Chan wrote last week that Hong Kong now faces a reversal from the low interest rate environment it has enjoyed for more than a decade.

“As the economy has not yet fully recovered from the epidemic, we must pay attention to the impact of rising interest rates … (on) people and small and medium-sized businesses “, he wrote on his official website.

Impact on the housing market

Hong Kong banks have so far kept their best lending rates steady but will feel the pressure in three to six months, analysts said.

Hong Kong housing market set to feel heat from interest rate hikes, analysts say
Hong Kong housing market set to feel heat from interest rate hikes, analysts say ISAAC LAWRENCE AFP

“The interest rate could rise faster than in the past, given the faster pace of the Fed and also the change in overall background risk sentiment around the world,” economist Gary told AFP. Ng of Natixis.

Homebuyers whose mortgages are tied to the Hong Kong interbank offered rate (HIBOR) will be the first to feel the heat, said economist Heron Lim of Moody’s Analytics.

“This generally has a downward effect on housing prices, (which) are also expected to decline in 2022 and 2023, especially if demand from mainland Chinese investors is weak,” Lim told AFP.

Hong Kong’s government said on Friday it expected signs of recovery later this year following the easing of coronavirus curbs that crippled the economy in the first quarter.

But rate hikes could dampen a domestic rebound, as the higher burden borne by homebuyers will eat away at their consumption power.

Small and medium-sized businesses also potentially face a “really tough time” if the rate hike coincides with a resurgence of Covid, economist Samuel Tse of DBS Bank told AFP.

Hong Kong is still sticking to a slimmed down version of China’s zero Covid model that has taken its toll on businesses in the city.

The “defensible” dollar peg

Hong Kong allows its currency to trade in a range of 7.75 to 7.85 against the greenback.

Capital outflows and the intense selling of the Hong Kong dollar over the past few months have pushed it to the weak end of this trading band.

Last week, the Hong Kong Monetary Authority (HKMA) spent HK$8.53 billion ($1.08 billion) in three attempts to prop up the local currency, the first intervention since 2019.

The Hong Kong dollar has been pegged to the US greenback since 1983
The Hong Kong dollar has been pegged to the US greenback since 1983 ISAAC LAWRENCE AFP

Some commentators have begun to question the sustainability of the peg, citing pandemic pressures and geopolitical tensions between China and the United States.

Responding to a Bloomberg op-ed, HKMA deputy chief executive Edmond Lau said earlier this month that the peg to the US dollar was a “very robust and transparent system” and “very resilient”.

“Hong Kong’s monetary base is fully backed by US dollar assets,” Lau wrote, adding that the government has large fiscal reserves and no net debt.

All four analysts who spoke to AFP agreed that Hong Kong would retain its peg despite changes in the global economy.

“Although the foreign exchange reserve has increased from $500 billion to around $460 billion, it is still a relatively high level that should be enough to defend the Hong Kong dollar,” DBS’s Tse said.

Moody’s Lim said the HKMA’s war chest ensured the tie-up was “highly defensible”, adding that the arrangement had political value as Hong Kong remained an international gateway to the Chinese economy.

Nataxis’ Ng noted that there were no panic selling or dumping of Hong Kong dollar-linked assets, which he said bodes well for the peg’s future.

“But in the medium to long term,” he added, “it depends on whether this monetary stability still has benefits that outweigh the costs, like the divergence… between China and the United States.” .