REVIEW OF 2006

Hong Kong’s foreign exchange and money markets were stable in 2006. Since the introduction of the three refinements to the Linked Exchange Rate system in May 2005, the Hong Kong dollar spot exchange rate has fluctuated between the central parity rate of 7.8 and the strong-side Convertibility Undertaking of 7.75, reflecting buoyant stock market activities, which raised equity-related demand for Hong Kong dollars (Chart 1).¹

The Hong Kong dollar spot exchange rate moved within a narrow range of 7.7510–7.7622 from January to April. Driven by interest carry trade taking advantage of the widening negative gaps between Hong Kong dollar interest rates and their US dollar counterparts, the Hong Kong dollar exchange rate weakened gradually from 7.7514 in May to 7.7946 in early October. Thereafter, the exchange rate strengthened towards the end of the year to close at 7.7763 on 29 December, mainly because of equity-related inflows. The market remained calm when the renminbi spot rate appreciated beyond the Hong Kong dollar weak-side Convertibility Undertaking of 7.85. This was the first indication of an apparent decoupling of the Hong Kong dollar spot exchange rate and the renminbi spot rate.

¹ In 2006 a record $525 billion was raised on the stock market, including a series of H-share IPOs amounting to $292 billion.