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HK banks seen hiking rates on Friday following Fed

HONG KONG: Hong Kong is poised for its second interest rate hike this year on Friday after the Federal Reserve's overnight decision to lift key US rates by a quarter percentage point.

Money market dealers said they widely expect the Hong Kong Association of Banks (HKAB) to boost deposit rates to 4.25 percent from 4.0 percent after its weekly meeting on Friday.

Banks usually followed an HKAB move with a corresponding action on their prime rate, their best lending rate, which is now at 8.75 percent.

"When three-month interbank rates near six percent, banks should raise lending rates in order to maintain profit margins," said a dealer at a Hong Kong bank.

The Hong Kong Monetary Authority (HKMA) on Wednesday boosted the base rate offered at its discount window, from which banks may borrow overnight liquidity, to 7.5 percent from 7.25 percent.

Because of the Hong Kong dollar-US dollar peg, if US rates go up and Hong Kong rates stay flat, institutions find it more attractive to hold US dollars and Hong Kong risks capital outflow.

"If you look at the Hong Kong dollar spot rate...it's basically at par with the convertibility undertaking rate. That means there's very little room for the HKAB to manoeuver here," said Nomura International's greater China economist Kevin Chan.

As a measure to strengthen the currency peg, the HKMA undertakes to convert banks' Hong Kong dollars into US dollars at a fixed rate known as the convertibility undertaking rate.

"If they don't follow the Fed's move, that would mean weakening of the exchange rate at the spot level," Chan said.

TIGHTER LIQUIDITY MEANS HKAB LIKELY TO HIKE

With on Tuesday's move, the Fed has tightened five times since June, a total of 1.25 percentage points, but Hong Kong banks have hiked only twice in that period, a total of 50 basis points.

Hong Kong, emerging from a two-year economic crisis, was able to hold off on further hikes, despite its currency peg, because of flush liquidity which let the banking system sustain some capital outflow.

But liquidity tightened significantly this year after the repatriation of Y2K-related funds and when it was clear the Fed would remain in tightening mode. More recently, tensions related to Taiwan's election of a pro-independence president had put additional pressure on interbank rates and US/HK forwards.

The aggregate balance of banks' Hong Kong dollar clearing accounts at the HKMA stood at only HK$468 million (US$60 million) on Wednesday, after a HK$358 million forex outflow.

HKAB chairman Raymond Or said last week there was "a very high possibility" the group would follow a US hike, though he said it would monitor capital flows and the Taiwan situation.

Some analysts earlier warned higher rates would jeopardise Hong Kong's nascent economic recovery, but an unexpectedly strong rebound in late 1999 put most of these fears to rest.

Moderating deflation would offset the impact of higher nominal rates on real interest rates broadly defined as nominal rates minus inflation so consumption and investment were still expected to rebound strongly in 2000.

Chan noted higher rates typically affected the economy after a lag of around nine months.

"The overall impact will not be that huge this year. It will be more for next year when loan growth hopefully will go back to positive and...there would be more room for banks to increase interest rates and that would impact the economy," he said.

Goldman Sachs said in a research report last week it expected the economy to grow 5.2 percent in 2000.

It expected prime rates to climb to 10.25 percent by end-2001, but this should be partly offset by rising long-term capital inflows with China's expected entry into the World Trade Organisation, stabilising growth at around 4.2 percent in 2001."-Reuters