US Federal Reserve chairwoman Janet Yellen has heightened expectations of another rate hike in December in her latest comments.
The Fed “should also be wary of moving too gradually”, Yellen said in a speech delivered to the National Association for Business Economics in Cleveland on Sept. 26.
In response, the rate futures market moved to price in over 70 percent probability of the Fed acting in December, up from about 33 percent early this month. The market is still expecting three rate hikes next year.
Nonetheless, various indicators show that Hong Kong banks still have plenty of room to delay a rate hike.
Firstly, we have yet to see massive capital outflows. The Fed and other major central banks have adopted monetary easing measures after the 2008 financial crisis. That has created enormous market liquidity; the US monetary base surged 3.8 times within a couple of years.
Massive capital then poured into Hong Kong and the city’s monetary base spiked.
As a result, deposits held by local banks have soared above HK$3.6 trillion over past nine years, with an annual growth rate of 9.7 percent.
Currently, Hong Kong’s monetary base is still trending up albeit at a moderating pace. That means the Hong Kong market still has ample liquidity. Therefore, local banks have little incentive to raise rates.
Secondly, Hong Kong banks have experienced a shift in their mortgage loan composition since the 2008 financial crisis.
In the past, prime rate-linked mortgages used to be mainstream. At present, 95.9 percent of mortgage loans are Hibor-linked, up from around 80 percent since the middle of 2014.
It’s estimated that mortgage loans account for more than half of the retail banking business for local banks or even close to 80 percent for some banks. For commercial loans to major clients, the interest rates are also largely linked to Hibor.
A rate hike in Hong Kong means banks raising their prime rate or best lending rate.
But doing so now won’t improve their bottom line. Quite the reverse, banks tend to raise deposit rates along with prime rate, which means higher costs. Local banks may hold back from raising rates unless Hibor spikes.
We can follow two main indicators. If one-month Hibor hits above 0.75 percent, Hibor-linked mortgage will be converted into prime-linked and there would be incentive for banks to hike.
Currently, the one-month Hibor stands at 0.57 percent, so we are still not there yet.
We can also pay attention to the exchange rate against the greenback.
Market arbitrage activity has picked up since the Fed tightened monetary policy, which has pushed up the US dollar.
If the exchange rate approaches the weak-side of the Convertibility Undertaking set at 7.85, prompting the Hong Kong Monetary Authority to sell the US dollar, market liquidity will be drained, and local banks may then have a stronger reason to raise rates.
This article appeared in the Hong Kong Economic Journal on Sept. 28
Translation by Julie Zhu
[Chinese version 中文版]
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