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HK dollar peg under strain, but seen likely to stay

HONG KONG, Oct 25 (Reuters) - Hong Kong's struggle to keep its currency peg to the U.S. dollar is coming under increasing economic and political strain, including risks that property prices will rise even higher, but there's little chance policy-makers will abandon it any time soon.

The third round of quantitative easing in the United States enacted in September, combined with increased optimism about China's economic prospects, has translated into fresh enthusiasm for Hong Kong dollars in October, forcing the Hong Kong Monetary Authority (HKMA) to repeatedly intervene to keep the currency within its permitted trading band.

The HKMA has already stepped into the currency market four times in less than a week, selling a total HK$14.4 billion ($1.85 billion) of Hong Kong dollars, and market observers say it will need to keep doing so.

``We expect net inflows into the Hong Kong dollar will continue for some time,'' the city's central bank said on Wednesday.

The HKMA's moves have successfully kept the exchange rate within its target range, currently between 7.75 and 7.85 per dollar, but sparked fears that the cash injection will find its way into the local property market - where the exorbitant cost of housing has become a source of political friction - and push prices even higher.

Given this mixture of expense and risk, some have called for Hong Kong to modify or abandon the 29-year-old peg between the Hong Kong and U.S. dollar.

Joseph Yam, an adviser to China's central bank and a former Hong Kong Monetary Authority chief, caused a furore this summer when he published a paper calling for Hong Kong to consider widening the trading range, re-pegging the currency to something besides the dollar, or doing away with it entirely.

But Financial Secretary John Tsang immediately threw cold water on the idea.

``We all agree that the linked exchange rate is most suitable for Hong Kong and there's no need whatsoever to make any change,'' he said.

Most analysts who spoke to Reuters also supported the current regime.

``Regardless of recent flows, I continue to believe the HKD peg to the U.S. dollar will persist since the system keeps the currency and economy stable,'' said Adrienne Lui at Citi Group.

ASSET PRICES

The Hong Kong government has moved to restrict the impact of hot money flows on residential property in particular, ordering banks to curb home loans to borrowers with more than one mortgage.

But injecting currency into the local economy, as the monetary auithority does with each intervention to maintain the dollar peg, counteracts such administrative measures.

``Inflows would further aggravate the existing excess liquidity condition, hence driving demand for property as a long-term hedge against it,'' Christiaan Tuntono, research analyst at Credit Suisse, said in a research note.

The Centa-City leading index (CCL), which evaluates secondary private residential property prices in Hong Kong, rose 2.79 percent to 111.19 during the week of Oct. 8-14 up, from the previous month, which was well above the peak in 1997.

On the upside, the prospect of fund flows returning to Hong Kong has also caused shares in Hong Kong Exchanges & Clearing to rally by nearly 10 percent.

The HKMA has intervened in currency markets in the past, sometimes to prevent speculative attacks, and at other times in response to global economic events. The last series of interventions took place following the collapse of Lehman Brothers in 2008, when the central bank sold HK$640 billion into the market.

The latest intervention will lift the aggregate balance -- the sum of balances on clearing accounts maintained by banks with the HKMA -- to HK$163 billion on Oct. 25, according to Reuters data.

The liberalisation and internationalisation of the Chinese yuan has added a new dimension to the debate.

The widening premium the yuan enjoys over the Hong Kong dollar against the U.S. dollar has caused some to suggest that the Hong Kong dollar should be re-pegged to the yuan.

The dollar/yuan rate currently stands around 6.25, compared with 7.74 for the Hong Kong dollar.

However, economists say such a change would need to follow, nor precede, the opening of China's capital account. At present most of the yuan in the world remains within China's borders. ($1 = 7.7500 Hong Kong dollars)

(Editing by Ken Wills and Raju Gopalakrishnan)