FINANCIAL AND MONETARY AFFAIRS
In the international foreign exchange market, the US dollar fell from around 100 Yen and 1.56 Deutschemark at the beginning of the year to a post-war low of 79.7 Yen on April 19 and 1.345 Deutschemark on March 8. After intervention by the Group of Seven in late May, the US dollar at one stage rebounded to 104 Yen and 1.5 D-mark in mid-September. The impact of the movement of the US dollar vis-à-vis other international currencies on the effective exchange rate index (EERI) of the Hong Kong dollar has been moderated by the heavy weight of the Renminbi (32.2 per cent) and the US dollar (17.6 per cent) in the index. During the year, the Renminbi showed a moderate appreciation of 1.5 per cent against the Hong Kong dollar.
The trade-weighted EERI of the Hong Kong dollar declined from 123.5 at the beginning of the year to the low of 117.7 on April 19 and then stabilised at around 118 at the end of June. As the US dollar subsequently gathered strength in the second half of the year, the EERI edged up and closed the year at 122.7, a 0.6 per cent decline from the beginning of the year.
On the interest rate front, the funds rate cut of 25 basis points (bps, or one- hundredths of one per cent) on July 6 was interpreted by the market as an end to the series of interest rate hikes by the US Federal Reserve ("the Fed') since February 1994. The last interest rate increase in this series took place on February 2, 1995, when the US discount rate was raised by 50 bps. Accordingly, the Hong Kong LAF bid and offer rates were raised by 50 bps to 4.25 per cent and 6.25 per cent, respectively. The LAF rates were left unchanged when the Fed funds rate was cut by 25 bps on July 6, as the US discount rate remained unchanged, and the Fed funds rate was well within the range set by the LAF bid and offer rates.
Apart from the January episode and the occasional quarter-end tightness, the overnight Hong Kong interbank offered rate (HIBOR) stayed within the range set by the LAF bid and offer rates during most of the year. Unfavourable news and market commentary on Japanese banks in the third quarter, however, increased borrowing costs of these major players in the interbank market. Temporary tightness in the interbank market pushed the HIBOR to touch the LAF offer rate on several occasions in September.
After the US interest rate hike on February 2, the HK dollar yield curve shifted downward gradually and flattened amid expectations that the US interest rate, and hence the Hong Kong dollar interest had peaked. As the Fed lowered its funds rate on July 6, the HK dollar yield curve moved downward significantly but soon firmed up again as the market expected that the Fed would not rush into another interest rate cut in the near future. The yields for three-month Exchange Fund Bills and five- year Notes fell by 15 bps and 149 bps, respectively over the period from early January to early July. Yields of the three-month bills edged up slightly by nine bps from then until the end of the year. Yields of the five-year notes, however, eased by a further 64 bps from early July to end-December, partly due to another 25 bps cut in the Fed funds rate on December 19. The spread over the corresponding US Treasuries for the five-year Exchange Fund Notes moved around 80 to 100 bps for most of the year.
After the rise in the LAF bid and offer rates in February, the Best Lending Rate quoted by major banks increased by 50 bps to 9 per cent. It was cut by 25 bps on December 27 after a corresponding cut in the Fed funds rate earlier that month. The interest rate cap on time deposits fixed for seven days or more was removed in three
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