Hong Kong to embark on journey of Quantitative Easing?

As the Hang Seng Index HK:HSI +0.12%  reached a six-month high, authorities on Friday had to intervene to stop the currency peg strengthening under pressure from hot money flows.

The Hong Kong Monetary Authority (HKMA) spent $603 million selling Hong Kong dollars to keep the currency within its permitted band — its first intervention since 2009. Renewed risk appetite after signs of stabilization in the euro zone and better news on China’s growth explained the inflows.

For global investors, intervention by Hong Kong’s de facto central bank is an important signal — the liquidity party is back on. How this party ends is less clear. The authority’s willingness to defend the near-three-decade-old currency peg further could be put to the test if inflows escalate and the greenback weakens.

So far, the impact of quantitative easing by the Federal Reserve in Hong Kong has followed a well-worn path, which this column discussed in July.

As overseas money flows arrive, they push down interbank rates, delivering a liquidity boost to the local economy. Because inflows cannot be absorbed by the currency strengthening due to the currency peg, this tends instead to drive up asset prices.

On cue, QE3 had already given a shot of adrenaline to the local property market. Prices have surged past 1997 highs, according to an index provided by Centaline Property Agency. Last month, prices hit a third consecutive monthly high, up 96% since 2008 and another 16% since the beginning of this year.

The equity market is also getting perkier. The stalled new-issues market is now preparing to bring back previously postponed listings from Zhengzhou Coal Mining Machinery and Fosun Pharmaceutical that could raise up to $1.1 billion.

But not everyone is ready to toast another liquidity roller coaster.

Much of the local population have been losers as asset gains and a weaker currency also drive up inflation and the cost of living — all another round of cheap money guarantees is a hangover.

Liquidity inflows from China have already been generating protests as overseas buyers crowd out locals and fan price rises.

The economy is also suffering. After successive rounds of quantitative easing, Hong Kong’s economy is stalling. Brokerage Daiwa reckons a stagflation scenario is underway, as inflation eats into demand.

For the new government of CY Leung, which came in on a platform of tackling unaffordable property in July, the timing of QE3 has been unhelpful. As well as property prices rippling higher under his watch, price hikes are spreading across the economy from utilities to transport to restaurants.

Leung also faces a tougher test holding the government line that the peg is the only way.

Last week’s currency intervention is the first since former HKMA chief Joseph Yam publicly raised the issue of the peg’s continued appropriateness in June.

Part of maintaining a peg is that Hong Kong must follow the interest-rate policy of the U.S. As well as noting its impact of inflation, Yam highlighted the reduced purchasing power of the Hong Kong dollar, particularly against the Chinese yuan.

The fact that an official who helped introduce the peg — and who defended it during crisis in 1998 — is now instigating this debate looks significant.

Via – MarketWatch

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