92 Financial and Monetary Affairs
domestic currency is linked, is sold to the currency board for the domestic currency (inflow into the Hong Kong dollar). It contracts when the foreign currency is bought from the currency board (outflow from the Hong Kong dollar).
The expansion or contraction in the monetary base leads interest rates for the domestic currency to fall or rise, respectively, creating the monetary conditions that automatically counteract the original capital movements, ensuring stability of the exchange rate.
A Currency Board Sub-Committee under the Exchange Fund Advisory Committee (EFAC) was established in August 1998 to oversee the operation of the currency board system in Hong Kong and recommend to the Financial Secretary through EFAC measures to enhance the robustness and effectiveness of Hong Kong's currency board arrangements.
The HKMA pursues a policy of transparency to ensure that the financial industry and the wider public are fully informed of the currency board operations. The Aggregate Balance and forecast changes to the Aggregate Balance attributable to the currency board's foreign exchange transactions are disclosed on a real-time basis. The size of the monetary base and its components are published every day, while the Currency Board Account is published each month. The records of the meetings of the Currency Board Sub-Committee are also published regularly.
The Government is fully committed to the maintenance of the linked exchange rate system, which is a cornerstone of Hong Kong's monetary and financial stability, and to the strict discipline of the currency board arrangement under that system.
Monetary Situation
The Currency Board continued to function smoothly in 2008 despite persistent capital inflows and the global financial turmoil. The money market was operating in an orderly way despite continued tension in the credit market. The HKMA introduced a number of measures to increase the supply of liquidity and reduce banks' borrowing costs. These measures helped alleviate the tension in Hong Kong's interbank market and mitigate the adverse impact of the credit strain on the wider economy.
The Hong Kong-dollar market exchange rate traded within a narrow range of 7.7710 and 7.8139 in the first eight months of 2008. The collapse of Lehman Brothers in mid-September sent shock waves through global financial systems, making the currency markets extremely volatile. The Hong Kong dollar generally strengthened alongside the US dollar during July to November, appreciating against the Australian dollar, the Korean won, the British pound and the Euro by over 20 per cent. The strong-side Convertibility Undertaking was repeatedly triggered in the last two months of the year, prompting the HKMA to passively sell Hong Kong dollars against US dollars at HK$7.75 to US$1.
Hong Kong-dollar interest rates generally declined in the first four months of 2008 along with their US dollar counterparts as the US Federal Funds Target Rate was lowered by a total of 225 basis points. The one-month and three-month Hong