The Operation of Monetary Policy

The Hong Kong dollar strengthened in the second quarter as the market sought to use it as a proxy hedge for an imminent renminbi revaluation. The appreciation of the Hong Kong dollar was interrupted when the HKMA announced the three refinements to the Linked Exchange Rate system on 18 May. The weak-side Convertibility Undertaking was triggered on the same day, causing the HKMA to buy HK$3.12 billion from banks, bringing the Aggregate Balance down from HK$3.83 billion to HK$714 million on 20 May. The optimism about the Hong Kong dollar resumed quickly amid a series of equity-related IPO activities in early June. In order to The HKMA’s announcement of the three refinements to the Linked Exchange Rate system on 18 May successfully removed the anomalies in the market, driving the Aggregate Balance back to a more normal level and aligning short-term Hong Kong dollar interest rates more closely with their US dollar counterparts. The introduction of an explicit strong-side Convertibility Undertaking cleared the uncertainty about how much the Hong Kong dollar can appreciate, and effectively ended the hoarding of Hong Kong dollar as a proxy hedge to the renminbi. Immediately after the announcement of the refinements, the weak-side Convertibility Undertaking of 7.8 was triggered, prompting the HKMA to buy HK$3.12 billion from banks. Thereafter, as political pressure from the US for renminbi revaluation intensified, the Hong Kong dollar exchange rate strengthened again. To address the rising demand for Hong Kong dollar funding for a number of equity initial public offerings (IPOs) in June, the HKMA conducted market operations within the Convertibility Zone on 25 May, selling HK$544 million to banks. Meanwhile, the US Federal Reserve raised the Fed funds target rate by a total of 50 basis points in May and June. However, yields on long-term Exchange Fund Notes declined modestly, in line with the movement in the yields of the corresponding US Treasuries.