Domestic prices and real activities have to carry weight of downward adjustment

If the HKD peg stays as projected.

It has been noted that the spotlight is back on the HKD peg as the HKD weakened to 7.82 against the USD last week and the 3M interbank rate (3M HIBOR) has edged up 30bps to 0.7% within two weeks.

According to a research note from UBS, it has been a while since the last bout of outflows amidst the European debt crisis in 2011/12, the HKD touched the weak side of the HKD's narrow trading range (7.75-7.85).

This, plus the jump in domestic interbank rates, surprised the market and fuelled questions on the peg's viability. The good news is that the HKD peg will stay, in UBS' view. Despite the volatilities and heightened market interests the last two weeks, the peg is still far from being seriously challenged.

Here's more from UBS:

There have been outflows from HKD, manifested in weaker HKD and higher HKD Hibor we have seen lately, but the outflows are yet to be massive or persistent enough to trigger the weak-side convertibility undertaking.

But as the peg stays, the bad news is something else has to givedomestic prices and real activities will have to continue to shoulder the bulk of downward adjustment.

The peg, by keeping the HKD weak and driving nominal rates to zero, had amplified the upturn during 2009-2014. The opposite has nevertheless been true since late 2014.