Hong Kong interest rates are on their way up after Hong Kong Monetary Authority (HKMA) refined theoperation of the Linked Exchange Rate System last month, accordingto the latest issue of the Hang Seng Economic Monthly Wednesday.

Under Hong Kong's currency board system, interest rates in Hong Kong should passively follow the movement of US interest rates.

However, such a relationship did not hold in the past 18 months when the Hong Kong market was awash with liquidity as a result of the inflow of funds.

The persistent low interest rates and their inability to rise along with US rates hide the fact that credit growth returned in 2004 and the banking sector's balance sheet expanded again.

The report pointed out that loan demand is improving along with the growing economy. Loans for use in Hong Kong rose 6.3 percent in 2004, while total loans outstanding for the banking sector recorded a 5.9 percent year-on-year increase. Lending in almost all major economic sectors showed different degrees of growth, indicating that the revival in loan demand has been broad-based across the whole economy.

However, the report noted that the loan expansion is only at a very early stage and is not strong enough to absorb the huge liquidity in the money market.

The strong inflow of funds since 2003 has resulted in the rapid expansion of money supply. Total customer deposits and negotiable certificates of deposit recorded an increase of 601 billion HK dollars (77 billion US dollars), or a rise of 17.4 percent, between December 2002 and December 2004.

The reports noted that although HKMA's new measures, creating a "convertibility zone" of 7.75-7.85 for the Hong Kong dollar versus US dollar, cannot eliminate Hong Kong dollar speculation from the market, the convertibility zone provides the HKMA with greater flexibility to correct interest rate differentials not consistent with the currency peg.

Source: Xinhua