The Hong Kong dollar exchange rate gradually depreciated to the linked rate of 7.80 during the first four months of 2004, as appreciation pressures slowly subsided and the HKMA conducted a number of strong-side operations (i.e. selling Hong Kong dollars for US dollars). Thereafter, the Hong Kong dollar exchange rate stayed close to the linked rate and the Convertibility Undertaking was triggered occasionally between April and September. The Hong Kong dollar exchange rate strengthened again in October, prompting the HKMA to conduct a number of strong-side operations in response to banks' bids. The exchange rate finally closed at 7.7745 at the end of the year. The renewed strength in the Hong Kong dollar reflected several factors, including weak sentiments towards the US dollar, speculation about the exchange rate policy in the Mainland, and improved prospects for the Hong Kong economy. For the year as a whole, the HKMA purchased (on a net basis) $16.6 billion worth of Hong Kong dollars from banks.

In light of interest rate hikes in the US, Hong Kong dollar interbank interest rates rose from April to September. However, interest rates started to ease in October, owing to capital inflows. As a result, the negative spread of Hong Kong dollar interest rates over US dollar counterparts widened. Short-term interest rates rose for a brief period between mid-November and early December, reflecting liquidity demand associated with equity IPOs. For the year as a whole, one-month interbank interest rates rose by 0.1488 percentage point to close the year at 0.2188 per cent. Despite a cumulative hike of 1.25 per cent in the US Federal funds target rate during the year, the best lending rate quoted by major banks in Hong Kong was unchanged at 5 per cent. The saving deposit rate quoted by major banks increased marginally from 0.01 per cent to 0.0125 per cent.

The yields on Exchange Fund paper largely followed those on US Treasuries, with the seven-year and 10-year Notes closing the year at 3.19 and 3.63 per cent respectively. Short-term yields on Exchange Fund paper increased, while long-term yields eased. The negative yield differentials between the Exchange Fund Notes and US Treasuries widened during the year, to -74 basis points and -65 basis points for seven-year and 10-year paper respectively.

The overall exchange value of the Hong Kong dollar, as measured by the trade-weighted Effective Exchange Rate Index (EERI), was mostly influenced by the exchange rate of the US dollar vis-à-vis other major currencies. Reflecting weakness in the US dollar against other major international currencies, the EERI decreased from 99 at the end of 2003 to 96 at the end of 2004.

Hong Kong dollar narrow money (HK$M1) continued to increase, and broad money (HK$M3) expanded along with the sustained revival in domestic economic activity in 2004. Specifically, HK$M1 (seasonally adjusted) rose by 16 per cent during the year, reflecting buoyant stock market activity as well as the low opportunity cost of holding liquid monetary assets due to near-zero short-term deposit rates. Meanwhile, growth of HK$M3 accelerated in the fourth quarter, after registering moderate rates in the first three quarters. Compared with the end of the previous year, HK$M3 grew by 4.6 per cent in 2004, largely in line with nominal GDP growth.

Following a moderate decline for the previous three consecutive years, loans for use in Hong Kong expanded by 6.3 per cent in 2004, reflecting increased demand for credit. Analysed by major usage, lending grew in most sectors in 2004. Trade financing and loans to the manufacturing sector, financial concerns, and the wholesale and retail trade registered notable increases. The outstanding stock of residential mortgage loans decreased slightly in 2004, as a marked expansion in new mortgage lending was offset by repayments on existing mortgages. As the rate of increase in Hong Kong dollar loans was higher than that in Hong Kong dollar deposits, the Hong Kong dollar loan-to-deposit ratio rose from 81.5 per cent at the end of 2003 to 82.6 per cent at the end of 2004.