Abundant liquidity sends Hong Kong dollar to weakest in 33 years

HONG KONG, March 7 (Reuters) - The Hong Kong dollar hit its weakest levels in 33 years on Wednesday as a lingering excess of liquidity in interbank markets has pushed the difference between local and U.S. rates to its widest since the global financial crisis.

Hong Kong’s markets have been flooded with liquidity over the past decade as heavy money printing by global central banks, led by the U.S. Federal Reserve, have directed large flows of new cash to the territory, whose financial centre serves as the main gateway to the outperforming Asian economies.

While liquidity in Hong Kong’s interbank markets has been dropping from a peak of over HK$400 billion ($51 billion) in 2015 as the Fed started to raise borrowing costs and other western central banks contemplate doing the same, current levels of around HK$180 billion are still not low enough to put upward pressure on HIBOR interbank lending rates.

“There is still a lot of excess liquidity in the interbank market ... (even if) money has been leaving quietly,” said Kevin Lai, chief economist for Asia ex-Japan at Daiwa Capital Markets, adding that the excess cash levels need to roughly halve before HIBOR rates see upward pressure.

The spread between three-month HIBOR and its LIBOR equivalent in the United States is now close to 1 percentage point, its widest since 2008.

The Hong Kong dollar dropped as low as 7.8348 on Thursday, the weakest since 1984.

The Hong Kong Monetary Authority, which matches Fed rate moves, allows the currency to fluctuate between 7.75 and 7.85 per U.S. dollar under its Linked Exchange Rate System introduced in 2005.

With the Hong Kong dollar approaching the weakest limit of the band, the HKMA is expected to soon intervene and mop up liquidity by issuing so-called exchange fund notes to banks at auctions.

“The last time USDHKD reached this level in 2007, the HKMA announced issuance of an HK$1 billion exchange fund note which caused HIBOR to spike and USDHKD to trade sharply lower,” Morgan Stanley strategists said in a note.

“With both the LIBOR-HIBOR spread and USDHKD at similar levels compared to the 2007 episode, we see an increasing probability that the HKMA will signal for further EFB issuance to drain HKD liquidity.”

The HKMA said the weakness is triggered by expectations of faster Fed rate hikes, which is widening interbank spreads, but its monetary policy was designed to address that imbalance when the exchange rate bands are hit.

“The easing of the HKD should not cause any particular concern. The triggering of the weak-side CU (convertibility undertaking) is something that the HKMA is expecting,” HKMA said in an email. ($1 = 7.8346 Hong Kong dollars)

Reporting by Marius Zaharia and Donny Kwok; Editing by Himani Sarkar