Interesting times in HK

The Fed raises interest rates, Hong Kong banks lower them.

So much for rising interest rates. Despite the US Federal Reserve's quarter-point hike on Wednesday night Hong Kong banks actually lowered their prime lending rate by 0.125% yesterday. That means the spread between US and Hong Kong prime rates just widened by 37.5 basis points.

The lower rates are not just a move against the Fed. Because of the Hong Kong dollar's peg to the US dollar the HKMA tends to stay in lockstep with its US counterpart, as it did yesterday by raising its base rate 0.25% to 3.5%. But banks ignored the Authority's lead once again - they have bucked three of this year's four. But this is the first time they have gone against it.

This extraordinary movement is caused by the billions of dollars of hot money that has been flowing into the Territory in the past few weeks. Excess liquidity in the banking system, the aggregate balance, has risen from HK$3 billion to HK$14 billion over the last month. With all that money chasing through the system rates are under huge pressure.

A lot of the hot money is anticipating that China will introduce exchange-rate flexibility soon and liquidity is so high that yields on short-term exchange fund bills actually dipped into negative territory on Monday - holders had to pay for the privilege of owning them.

According to Leland Sun, CEO and founder of finance boutique Pan Asian, this trend of divergent US and Hong Kong interest rates could be set to continue, not least because of huge competition among the banks that is being driven by their growing funding gap - lots of deposits, few loans. "They're dying for assets," he says.

With a widening spread between Hong Kong and US rates it could be time to start switching Hongkies into greenbacks. These are indeed interesting times.

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