September 21, 2018 / 4:03 AM / a month ago

UPDATE 2-Hong Kong dollar spikes on rate rise expectations

* HK dollar hits highest level since late February

* Traders see spike rooted in expected Fed, local rate hikes soon

* HKMA says HKD, money markets are operating in an orderly manner (Adds Hong Kong Monetary Authority comment)

Sept 21 (Reuters) - The Hong Kong dollar experienced a sudden, sharp spike on Friday, pulling it off the weak end of its narrow trading band where it had been stuck at for six months.

Expectations of a rise in bank lending rates and tightness in cash supplies appeared to cause the Hong Kong currency to climb to 7.8244 to the U.S. dollar, its highest level since late February. Since March, it had stayed near 7.85, the lower end of the Hong Kong Monetary Authority’s managed trading band.

Traders couldn’t entirely explain Friday’s move, although some pointed to a rise in Hong Kong interbank rates (HIBOR) as evidence of expectations that domestic banks might raise their prime rates next week, on the heels of another possible rate rise by the U.S. Federal Reserve.

“It could possibly be a combination of a few factors at play that are causing fears of liquidity tightening,” said Albert Leung, a strategist at Nomura.

“The aggregate balance is lower than before, there is some money locked up in IPOs,” he said. “Also, there is the mid-Autumn festival and the month-end coming up. There is some fear post-FOMC next week, where the expectation is for a rate hike, that there could be an increase in Hong Kong’s prime rate.”

The HKMA maintains the currency peg by managing the aggregate balance, which is the total amount of Hong Kong dollar deposits that banks keep with the authority. Under a complex formula, the HKMA’s base rate shadows the Fed funds rate.

A HKMA spokeswoman said market participants viewed the elevated interbank interest rates as a contributing factor to the latest strengthening of the Hong Kong dollar.

“We note that the HKD foreign exchange and money markets are operating in an orderly manner,” the spokeswoman said in an email reply to a request for comment. “We will continue to maintain the effective operation of the Linked Exchange Rate System.”

The Fed’s steady rate rises since the end of 2015 have led to HIBOR lagging U.S. dollar yields, causing capital outflows from Hong Kong.

Over the past year, as the currency weakened past 7.8 per U.S. dollar to its weakest at 7.85, the HKMA had as part of efforts to defend the peg been issuing bills to mop up cash and reduce the aggregate balance.

The HKMA has raised its base rate in lockstep with the Fed, but the city’s commercial banks have left their prime rates unchanged at decade-lows and only recently started to edge up mortgage rates.

HIBOR rates have increased, with the one-month rate up by 50 basis points to 1.73 percent since mid-August. The spread between 3-month HIBOR and LIBOR has narrowed since to around 30 basis points from 130 in April, its highest levels since 2008.

Meanwhile, a brief announcement from China’s central bank that it had agreed with the HKMA on issuing its bills in the former British colony also stoked speculation about a reduction in offshore yuan supplies.

Analysts had been expecting the selling pressure on the Hong Kong dollar to persist.

“If the Fed hikes rates in September, then the differential between Hong Kong and the U.S. rates will go wider, which will lead to increased capital outflows and cause weakening pressure on the Hong Kong dollar,” said MK Tang, senior China economist at Goldman Sachs. (Reporting by Hideyuki Sano in TOKYO, Divya Chowdhury in MUMBAI and Donny Kwok in Hong Kong; Writing by Vidya Ranganathan; Editing by Kim Coghill and Richard Borsuk)

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