Hong Kong dollar seen staying weak, thanks to low local interest rates

By Michelle Chen

HONG KONG, Jan 29 (Reuters) - No matter how low the U.S. dollar might go, one Asian currency that has not strengthened against it recently is expected to stay weak - the Hong Kong dollar.

Hong Kong's currency is a case by itself, as it is pegged against the U.S. dollar and only trades in a narrow band.

But in the past month, when many Asian currencies have surged versus the U.S. dollar, the Hong Kong dollar has hovered near the band's weak side and is expected to stay there in the short-term.

A main reason for weakness is ample liquidity in the financial system, which keeps a lid on Hong Kong dollar interest rates.

The HK dollar, which can fluctuate between 7.75 and 7.85 per U.S. dollar, touched 7.8195 on Monday, close to its historic lows at 7.8305.

Ken Cheung, senior Asian FX strategist at Mizuho Bank, predicts the currency "will trade between 7.80 and 7.83 in the near term, with upside bias to 7.85".

It strengthened in December due to relatively tight liquidity - as often seen near year-end. But this wasn't sustained and the spread between the HK dollar and U.S. rates widened, he said.

INFLOWS FROM CHINA

Spreads between the Hong Kong Interbank Offered Rate (HIBOR) and LIBOR widened sharply last year as markets priced in steadily rising U.S. rates.

That spread "is still wide at around 1 percent for overnight contracts, which has triggered a lot of arbitrage trades that long the U.S. dollar and short the Hong Kong dollar," said Ngan Kim Man, deputy treasury head at China Everbright Bank's Hong Kong branch.

Though the Hong Kong Monetary Authority (HKMA) followed suit with the U.S. Federal Reserve's rate hikes, liquidity in Hong Kong market remains sufficient.

Raymond Yeung, ANZ's Greater China chief economist, sees "quite strong" inflows to Hong Kong's exchange from the mainland as one factor.

This year, the Hang Seng index is up around 10 percent and the H-share index of China firms has gained nearly 18 percent.

The last time the HKMA issued an additional Exchange Fund Bill (EFB), used to drain liquidity, was Oct. 24. In November, the Hong Kong dollar bounced to 7.7922, its strongest level in five months.

Asked why it doesn't sell an additional EFB as the Hong Kong dollar is quite weak, an HKMA spokeswoman replied that such issuance was to meet strong demand from banks and "had nothing to do with movements of the HKD exchange rate".

($1 = 7.8171 Hong Kong dollars)

(Reporting by Michelle Chen; Editing by Richard Borsuk)