FINANCIAL AND MONETARY AFFAIRS
The new measures were put to market tests when there were brief periods of capital outflow in mid-September and late October. In the former incident, market anxiety over a reportedly imminent move of the exchange rate under the Convertibility Undertaking in respect of the Aggregate Balance from 7.75 to 7.80 triggered a significant outflow of Hong Kong dollars on September 14. The day-end forecast aggregate of the Aggregate Balance on September 16 shrank to a negative level of $7.5 billion.
Helped by a greater assurance of day-end liquidity through the Discount Window, the money market reacted calmly and in an orderly manner to the liquidity shortage. Overnight HIBOR rose moderately from around 5.5 per cent to a high of 9.25 per cent (on September 16) while the one-month interbank interest rate firmed from 8.25 per cent to a high of 12.25 per cent. By the end of September 16, the overnight and one-month HIBOR rates eased back to 7 per cent and 9 per cent respectively.
The other test occurred in late October when market participants switched out of Hong Kong dollar as short-term interest rates fell below corresponding US dollar interest rates. As a result, the Aggregate Balance fell from a level of around $2.9 billion in early October to $1 billion on October 29. In response, one-month and three-month interbank interest rates firmed slightly to 6.63 per cent and 7.06 per cent respectively. The rise in interest rates stemmed the outflows and induced some inflow of funds, restoring the Aggregate Balance to $2.3 billion on October 30. The one- month and three-month interbank interest rates eased back to 6.18 per cent and 6.88 per cent respectively on the same day.
Since the introduction of the new measures in early September, market sentiment has improved significantly. Reflecting also a decline in US interest rates, Hong Kong dollar interest rates in general moved on a downward trend. One-month and three- month interbank interest rates fell gradually from 18 per cent and 15 per cent respectively at end-August to 5.13 per cent and 5.25 per cent at the end of 1998, around 2 per cent and 4 per cent lower than the level at the beginning of the year. In line with the easing in interbank interest rates, both the HKAB savings deposit rate and the best lending rates quoted by major banks were cut on four occasions by a total of 1 per cent from October to December, and stood at 4.25 per cent and 9 per cent respectively at the end of the year.
The interest rate differential between Hong Kong dollar and US dollar was mainly affected by the uncertainties in the region. It rose when bouts of selling pressure on Hong Kong dollar emerged in January, June and August. As market conditions stabilised and investor confidence improved since September, the interest rate differential, in terms of one-month and three-month interbank interest rates over their corresponding US dollar interest rates, narrowed substantially to 7 bps and 19 bps at the end of 1998, compared with 147 bps and 346 bps at the beginning of the year. The average daily differential between the three-month Hong Kong dollar interest rate and its US dollar counterpart also narrowed from 354 bps in the first nine months of the year to 89 bps in the last quarter.
The yields of long-term Exchange Fund Notes were largely consistent with movements of the short-term Hong Kong dollar interest rates. The yields of both seven-year and 10-year Exchange Fund Notes rose to around 10.5 per cent at the end of June. The yields eased gradually after the introduction of the technical measures in September to 6.28 per cent and 6.36 per cent at the end of 1998, 285 bps and 281 bps
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