Hong Kong’s central bank follows the Fed, cuts base rate by 50bp to 5.25%

You’ll notice that the HKMA base rate is slightly above the Fed Funds rate.

The HKD trades in a band linked to the US dollar prescribed by the HKMA. You can see the limits of the band in the chart below.

The Hong Kong Monetary Authority (HKMA) adjusts its interest rates in line with the U.S. Federal Reserve’s decisions primarily because of the linked exchange rate system between the Hong Kong Dollar (HKD) and the United States Dollar (USD).

Established in 1983, this system pegs the HKD to the USD within a narrow band, currently at a rate of about 7.8 HKD to 1 USD, with allowable fluctuations within a tight range.

To keep the currency peg stable, the HKMA must adjust its interest rates to be in line with those of the USD. If the interest rates in Hong Kong were significantly higher than those in the U.S., it would attract a flow of USD into Hong Kong, increasing the demand for HKD and potentially pushing the exchange rate outside its designated band. Conversely, if Hong Kong’s rates were much lower, it would encourage outflows of HKD in exchange for USD, again risking the stability of the peg.

This article was written by Eamonn Sheridan at www.forexlive.com.