Monetary Authority Chief Executive Joseph Yam says managing market expectations is a challenging task, but it can be achieved by providing objective analysis and explanation.

In his Viewpoint column published today, Mr Yam said, although the authority cannot determine the interest-rate level in Hong Kong, given the monetary policy objective of exchange-rate stability, it still provides an abundance of analysis concerning local interest-rate movements.

"The message we have been conveying is that the trend in our interest rates should follow closely that of US interest rates, but in the short term there can be significant deviations owing to factors specific to Hong Kong."

Depending on the nature of these Hong Kong-specific factors, the deviations can be quite large and may persist, as in the case of the 18-month period prior to the introduction of the three refinements to the Linked Exchange Rate system in May this year.

Sudden interest rate changes expected

"Expectations of an appreciation of the yuan exchange rate and speculation that the Hong Kong dollar exchange rate might appreciate along with it had caused our interest rates to be significantly lower than those of the US dollar, despite successive increases in the latter.

When the temporary deviations are removed, either by the market on its own or by deliberate actions on our part, the return of our interest rates to normal, that is, back to convergence with US interest-rate levels, may be a sudden and disruptive one."

It may also overshoot, meaning the Hong Kong dollar interest rates may become higher than US dollar interest rates, and this phenomenon is likely to be manifested in deposit and lending rates, rather than in the interbank rates.

Overshooting can be avoided

Mr Yam said overshooting in financial markets is  common, but it is also something that can be avoided or at least mitigated by providing the market with relevant analysis and explanations.

"This is what we have been trying to do, and the banks concerned have also been forthcoming with their views in relation to the recent increases in interest rates."

His concern has been the removal of the short-term deviation and the possible subsequent overshooting with added confusion caused by the different best-lending rates in the market might give the impression of an uncontrollable leapfrogging process that might shock the market.