What the peg is
The Hong Kong dollar is pegged to the US dollar through the Linked Exchange Rate System, run by the Hong Kong Monetary Authority, known as the HKMA. The system dates from 1983. Under it, the exchange rate between the two currencies is kept within a narrow band of 7.75 to 7.85 Hong Kong dollars per US dollar.
Hong Kong operates the system as a currency board. In simple terms, the Hong Kong dollars that make up the monetary base are backed by US dollar reserves, and the HKMA stands ready to exchange one for the other at set rates. That commitment is what keeps the market rate inside the band.
The peg is a monetary policy choice by Hong Kong's authorities. It is not a fixed rate in the sense that USD/HKD never moves. It moves, but only within the band, and the HKMA's undertakings define what happens at each edge.
The convertibility band
The band has two edges, each backed by a convertibility undertaking from the HKMA.
- The strong side, at 7.75. If demand for Hong Kong dollars pushes the rate down to 7.75, the HKMA will sell Hong Kong dollars and buy US dollars from banks at that rate. This stops the Hong Kong dollar strengthening beyond 7.75.
- The weak side, at 7.85. If selling pressure pushes the rate up to 7.85, the HKMA will buy Hong Kong dollars and sell US dollars to banks at that rate. This stops the Hong Kong dollar weakening beyond 7.85.
Between the two edges, the rate is set by the market. The HKMA may also operate within the band, but the firm commitments sit at 7.75 and 7.85.
A quick way to remember the direction: a lower number means a stronger Hong Kong dollar, because fewer Hong Kong dollars are needed to buy one US dollar.
How the peg holds in practice
When the HKMA buys or sells Hong Kong dollars at either edge, the money supply in Hong Kong changes. If it buys Hong Kong dollars at 7.85, it takes them out of the banking system, which tends to push local interest rates up and make holding Hong Kong dollars more attractive. If it sells Hong Kong dollars at 7.75, it adds them to the system, which tends to push local rates down. This automatic adjustment is the heart of a currency board.
A practical consequence is that Hong Kong dollar interest rates broadly follow US dollar rates over time, though the two can diverge for periods. Hong Kong gives up an independent interest rate policy in exchange for exchange rate stability.
For a business, the detail of the mechanism matters less than the result. USD/HKD trades in a narrow range, and the market has a clear and public reference for where the limits sit.
What the peg means for exchange rates
Because the Hong Kong dollar tracks the US dollar, its value against every other currency moves almost in step with the US dollar's. If the euro strengthens against the US dollar by a given percentage, it strengthens against the Hong Kong dollar by nearly the same percentage.
That has a useful implication. For a European or Canadian company, the currency risk on Hong Kong dollar costs is almost the same as the risk on US dollar costs. A Canadian firm paying both US dollar suppliers and Hong Kong dollar rent effectively has one exposure, to the US dollar bloc, with a small extra movement within the band.
Within the band, the range is about 1.3% from edge to edge. On a payment of a few hundred thousand dollars that is not trivial, but it is small compared with the movements a floating currency can show over the same period.
Paying in HKD or USD
Many Hong Kong suppliers, especially in trade and logistics, invoice in US dollars. Others invoice in Hong Kong dollars, particularly for local services such as rent, salaries, professional fees and utilities. Businesses dealing with Hong Kong often have a choice, and a few points help decide.
Match the underlying cost. If a supplier's own costs are in Hong Kong dollars, paying in Hong Kong dollars means neither side carries a conversion. If the supplier buys goods in US dollars, paying in US dollars is usually simpler for them.
Count the conversions. If you hold US dollars and the supplier accepts US dollars, paying in US dollars avoids a conversion on your side. If the supplier then converts to Hong Kong dollars, they bear that cost and may build it into their price. Somebody always pays for each conversion.
Watch the receiving account. A US dollar payment sent to a Hong Kong dollar account will usually be converted by the receiving bank at its own rate. Confirm the currency of the beneficiary's account before sending. Many Hong Kong businesses hold multi-currency accounts with one account number and several currency sub-accounts, so the currency code on the payment matters.
Think about the cross. If you start in euros or Canadian dollars, you face a conversion either way. EUR/HKD and EUR/USD will be priced off the same underlying dollar market, so the cost difference between the two is often small. Compare quotes on the same terms.
A worked example
This example uses hypothetical rates for illustration only.
A Vancouver company owes its Hong Kong logistics agent HKD 780,000 for local warehouse charges. The company holds US dollars. The agent will accept either currency. If paid in US dollars, the agent would convert the funds into Hong Kong dollars through its own bank.
- Option one: the company buys HKD 780,000 against USD. At a hypothetical USD/HKD rate of 7.8000, the cost is 780,000 divided by 7.8000, which is USD 100,000.
- Option two: the company sends USD 100,000 and the agent converts it at its bank. If the bank's rate is 7.7600, the agent receives HKD 776,000, which is HKD 4,000 short of the invoice.
In option two the agent either absorbs the shortfall or asks for the balance. The underlying point is that the conversion happens either way. The question is who does it, at what rate, and whether the invoice is settled in full. Agreeing the currency and amount with the supplier before paying avoids a follow-up invoice for a few thousand dollars.
Settlement practicalities in Hong Kong
Spot USD/HKD settles T+2, like most pairs. Hong Kong has a well-developed clearing infrastructure. Its Clearing House Automated Transfer System, known as CHATS, settles high-value payments in Hong Kong dollars, and parallel systems in Hong Kong handle US dollar, euro and renminbi payments locally.
Hong Kong's public holidays affect Hong Kong dollar value dates. Lunar New Year is the most significant, because several consecutive holidays can push settlement out by a number of days. Plan supplier and payroll payments around it well in advance.
Severe weather can also disrupt the working day. When serious typhoon or rainstorm warnings are in force, some businesses and bank branches close or operate on reduced arrangements. Hong Kong’s arrangements for banking and financial market services during severe weather have been revised in recent years, so check the current position with your bank and build a margin into anything time-critical during the typhoon season.
Time zones matter for anyone paying from North America. Hong Kong is many hours ahead of Vancouver, and the Hong Kong banking day can be over before the Canadian day begins. Payments for a given Hong Kong value date often need to be instructed the previous afternoon in Vancouver.
Invoicing and price lists
The peg also affects how businesses set prices for Hong Kong customers and suppliers. Because USD/HKD moves so little, many companies quote Hong Kong customers in US dollars and let the customer convert, or quote in Hong Kong dollars at a fixed conversion they review only occasionally. Both approaches are common and both work, provided the terms are clear.
If you sell into Hong Kong from Europe or Canada, your real exposure is to the US dollar. A price list in Hong Kong dollars set when EUR/USD stood at one level will be worth more or less to you in euros when it moves, in almost exactly the same way as a US dollar price list. Review it on the same schedule as your US dollar prices.
If you buy from Hong Kong, an invoice in Hong Kong dollars and one in US dollars carry nearly the same risk for you. The choice usually comes down to which currency you already hold, which one the supplier prefers, and who you want to bear the cost of the single conversion that one side or the other must make.
For intercompany charges between a Hong Kong subsidiary and its parent, agree in writing which currency the charge is in and which rate source will be used to convert it for accounting. A clear rule avoids small differences building up between the two sets of books.
What the peg does not do
The peg removes most, but not all, movement between the Hong Kong dollar and the US dollar. It does nothing to reduce movement between the Hong Kong dollar and the euro, sterling, the Canadian dollar or any other currency. A European company with Hong Kong dollar costs still has a full exposure to EUR/USD.
The peg is also a policy commitment. It has been maintained through several periods of market stress, and Hong Kong's authorities have repeatedly stated their commitment to it. Even so, no business should treat any exchange rate arrangement as a guarantee when assessing risk over long horizons. That is a matter for your own judgement and your own advisers.
General information
This article is general information about the Hong Kong dollar's Linked Exchange Rate System. It is not investment advice and does not forecast or recommend any course of action. Rates in the example are hypothetical.
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