Hong Kong Dollar: Time has come for higher lending rates and perhaps lower asset prices

Hong Kong is set to embrace higher lending rates. Not only during the era of the global quantitative easing, rates in Hong Kong ha ve also stayed at an ultra-low level even after the FED started its hiking cycle. As the FED is expected to raise rates again on September 26 and the HKD remains at the weakest point of the band, the only directi on for Hong Kong ’ s rates to go is upwards. While the uptick has already started in the money market (HIBOR) and, more recently, for retail deposit rates, the key is when and how much will lending rates move up. We believe the time has come for a more rapid increase. Although the HKD has finally rebounded today due to tighter liquidity condition, it has been hover ing at the weakest point of its 1 percent age band since March 2018 , which prompted the Hong Kong Monetary Authority (HKMA) to intervene increasingly frequently to ensure that the HKD maintains its peg to the USD. Such intervention has reduced the HKD liquidity in the banking system and, thereby , the mo netary base. As a consequence , HK D money market rates (HIBOR) have crept up although very slowly. Still, there continues to be a negative interest rate differential between the HKD and the USD, which is behind c a rry trade activity with HKD as the funding currency. Beyond the c a rry trade, there is another reason for us to believe that the HKD interest rate s will be pushed higher more rapidly. T he quick d ecline i n deposit growth has stretched the HKD loan-to-deposit ratio to 85 % in July 2018 from 77% in end-2016 . Higher rates are needed to attract more depos its for banks to continue l e nd ing . T he driver behind the lending boom is higher exposure to Chinese firms with liquidity channelling back to China or overseas for acquisitions . Going forward, we expect the HKD interest rates to move up quicker due to the capital outflows from carry trade activities and loans to Chinese corporates, especially when deposit growth is decelerating . A shrinking monetary base and higher interest rates should put pressure on different asset classes. After the recent correction in the stock market, we should not be surprised to see other asset classes , namely the real estate, to be affected. This may not be such a bad outcome as the HKMA has been unable to control the asset bubble (especially in properties ) with macro - prudential tools. There was a delay but Hong Kong will follow the FED with higher rate s soon.