Hong Kong Property: The Fallacy of Low Interest Rates21 February, 2011, 18:03. Posted by Zarathustra
Tags: Hong Kong, Property, Real Estate
Because Hong Kong dollar is pegged with the US dollar, it is commonly assumed that as long as the US economy is still screwed, there’s no way for interest rates to go up in Hong Kong because the interest rates in the United States will not go up, so home prices in Hong Kong can only go up. Well, this is the argument from the bulls.
This is true in general. The overnight Hong Kong Interbank Offered Rate (HIBOR), possibly the closest equivalent to the Effect Federal Funds Rate, tracks Fed Funds Rate pretty well.
Source: Hong Kong Monetary Authority, St. Louis Fed
However, I have circled a period where overnight rate in Hong Kong deviated significantly from the Effective Fed Funds Rate. That was, of course, the 1997 Asian Financial Crisis, when the currency board system adjusted the interest automatically upward as massive speculative outflow of Hong Kong dollar happened. In fact, at the height of the crisis, overnight HIBOR reached level above 100% as funds flowed away from Hong Kong. On the contrary, the interbank rates in Hong Kong have been consistently lower than Effective Fed Funds Rate between 2003 and 2008.
Under the Linked Exchange Rate System of Hong Kong, the Hong Kong Monetary Authority (HKMA) commits to buy US dollar at the exchange rate of HK$7.8 when funds flow into Hong Kong pushes up the demand and hence the price of Hong Kong dollar. So when there is inflow of funds, the aggregate balance will increase, hence the monetary base. That will mean higher liquidity in the interbank market, thus lower interest rates. On the contrary, if there’s an outflow of fund which pushed down the price of Hong Kong dollar, HKMA will buy Hong Kong dollar and sell US dollar, thus the aggregate balance and monetary base will shrink. As liquidity is squeezed, interest rates would rise.
So even interest rates in Hong Kong have historically tracked pretty well with that of the United States, low interest rates environment in the United States is neither necessary nor sufficient condition for a low interest rates environment in Hong Kong. As long as money is coming in, interest rates will stay low regardless where the money is coming from and what the interest rates are in the United States. The point I want to make here is that it is completely wrong to look only at the interest rates in the United States to predict interest rates in Hong Kong. As long as there is an outflow of funds away from Hong Kong, interest rates will rise regardless of the interest rates in the United States.
Why would funds flow out of Hong Kong? At this point, I would let you speculate yourself.