ENG-2000 — Page 131

FINANCIAL AND MONETARY AFFAIRS

underlying demand for Hong Kong dollar assets. This was particularly noticeable in the second half of the year, when the differentials in terms of one-month money widened to around -120 basis points on several occasions, partly reflecting increased portfolio inflows to the equity market from June to mid-August, underpinned by buoyant expectations of equity returns on the back of the improved outlook for the Hong Kong and Mainland economies, and partly market perceptions of Hong Kong as a safe haven amid volatile regional markets towards the end of the year. The banking system also saw an increase in Hong Kong dollar deposits, which outpaced the growth of Hong Kong dollar loans. The impact of portfolio shifts into Hong Kong dollar assets was largely borne by interest rates and equity prices, while the exchange rate for the Hong Kong dollar remained stable.

The yields on long-term Exchange Fund Notes largely followed those on US Treasuries. After easing in the first quarter of 2000, they rose on the back of several interest rate rises by the Federal Reserve, with the yields of seven-year and 10-year Exchange Fund Notes reaching around 7.56 per cent and 7.80 per cent respectively in mid-May. Thereafter, as signs of economic slowdown in the United States prompted expectations of interest rate cuts, yields moved on a general downtrend for the rest of the year and closed at 6.14 per cent and 6.46 per cent at the end of December. The yield differentials between seven-year and 10-year Exchange Fund Notes and their US counterparts closed at 89 and 127 basis points at end-December, compared with 75 and 122 basis points at the end of 1999.

The overall exchange value of the Hong Kong dollar, as measured by the trade- weighted Effective Exchange Rate Index (EERI), was predominantly affected by the exchange rate of the US dollar vis-à-vis other major currencies. Largely reflecting a strengthening of the US dollar against the Japanese Yen and the Euro, the EERI moved on a general uptrend during the first 11 months of 2000. The EERI increased from 131.5 at end-1999 to a high of 137.5 in late November. Towards the end of 2000, the EERI decreased slightly to 136 at end-December, along with the weakening of the US dollar against the Euro.

Reflecting an increase in cash holdings associated with the transition into the year 2000 and the Chinese New Year holidays, and a rise in demand deposits due to active initial public offering activities, year-on-year growth of Hong Kong dollar narrow money (HK$M1) accelerated significantly to 15 per cent in December 1999 and further to over 20 per cent in the first two months of 2000. Thereafter, it stabilised at around 7 per cent during April to November, except for some occasional gyrations in July and September. However, because of the inflated level of cash holdings in December 1999 relating to the Y2K factor, HK$M1 recorded a 0.7 per cent decline in the year to December 2000. The growth of Hong Kong dollar broad money (HK$M3) remained stable at around 4-6 per cent for most of 2000, following a rise of around 5 per cent in 1999. This was largely in line with nominal GDP growth.

Along with sustained economic recovery, the decline in loans for use in Hong Kong moderated notably in the first seven months of 2000, and reverted to a modest increase from August. Following a fall of around 8 per cent in 1999, loans for use in Hong Kong rose slightly by 1.7 per cent in 2000 compared with a year earlier. This, however, continued to lag behind the strong economic growth. The slow revival of lending is largely attributable to subdued demand which was associated mainly with downturn in the property market, which has traditionally been a main driver for both corporate and personal lending. Reflecting faster growth of Hong Kong dollar

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