Monetary conditions were stable in 2002. The Hong Kong dollar exchange rate stayed close to the linked rate of 7.8, trading within a range of 7.7980 and 7.8000. Hong Kong dollar interest rates remained in the vicinity of their US dollar counterparts.

    The exchange and money markets reacted calmly towards uncertainties in the external and internal environment, including the abolition of the currency board system in Argentina, the weakening of the Japanese Yen in the latter part of the year, speculation about a change in the Link and concerns about the budget deficit. The resilience of these markets reflected confidence in the linked exchange rate system, which has been reinforced by the technical reforms introduced in September 1998. During the year, the convertibility undertaking was triggered once. The HKMA purchased US dollars for Hong Kong dollars twice.

    Hong Kong dollar interest rates were on a moderate downtrend during the year, along with the reduction in US dollar interest rates. Nevertheless, reflecting renewed concerns of an increasing budget deficit, short-term interest rates generally maintained a small positive differential against their US dollar counterparts (except for the third quarter when interbank liquidity was relatively abundant). In terms of one-month money, Hong Kong dollar interbank interest rate (HIBOR) closed the year at 1.4 per cent, six basis points above the corresponding Euro-dollar rate. The best lending rate quoted by major banks in Hong Kong was lowered by a total of 13 basis points during the year. It stood at 5.0 per cent at year-end. The savings deposit rate quoted by major banks followed a similar downtrend, declining from 0.15 per cent to around 0.03 per cent.

    The yields on long-term Exchange Fund Notes largely followed those on US Treasuries, with 7-year and 10-year Notes closing the year at 3.8 and 4.4 per cent respectively. The yield curves flattened during the year, mainly reflecting subsided concerns over the inflation outlook in the US. The yield differentials between the Exchange Fund Notes and US Treasuries narrowed during the year, to 33 basis points and 44 basis points respectively for 7-year and 10-year paper.

    The overall exchange value of the Hong Kong dollar, as measured by the trade-weighted Effective Exchange Rate Index (EERI), was predominantly affected by the exchange rate of the US dollar vis-à-vis other major currencies. Largely reflecting a weakening of the US dollar against the Japanese Yen, the Euro as well as the Sterling Pound, the EERI declined from 106 at the end of 2001 to a low of 102 in mid-July 2002. Thereafter, the index rebounded somewhat as the Yen depreciated on renewed concerns about the pace of banking sector reform in Japan. Towards the end of the year, a weakened economic outlook in the U.S. exerted downward pressures on the US dollar, leading to a decline in the EERI, which closed at 102.

    Growth of Hong Kong dollar narrow and broad money diverged notably in 2002. The Hong Kong dollar narrow money increased by 12.9 per cent during the year, while broad money contracted by 0.6 per cent. The strong growth of the narrow money reflected in part a low opportunity cost of holding non-interest bearing monetary assets as well as an increase in cash demand associated with a rising number of tourists from the Mainland. The small decrease in broad money was attributable to a fall in time deposits, which was in part due to portfolio shifts for higher returns on the back of record-low deposit rates relative to yields on alternative assets, such as debt securities.

    Loans for use in Hong Kong shrank for the second consecutive year by 2.4 per cent in 2002, reflecting the weak economic conditions. Analysed by economic use, the fall was broad-based. In face of the sluggish property market activities, loans for building, construction, property development and investment contracted moderately, while residential mortgage loans registered a small decline in 2002, following a rise in 2001. Outstanding credit card advances, which have registered strong increases in recent years, declined in 2002, probably reflecting tightening of credit card issuance and lending policies alongside continuing deterioration in loan quality and weak consumer spending. Loans for trade financing increased during the year, as external trade improved. As Hong Kong dollar deposits dropped less than Hong Kong dollar loans, the Hong Kong dollar loan-to-deposit ratio fell marginally to 88.5 per cent at the end of 2002, from 88.8 per cent a year earlier.