The US Federal Reserve is expected to continue cutting its key federal funds target rate in the remainder of the first half of 2008, as the downside risk to growth remains, Janus Chan, an economist at HSBC in Hong Kong writes in a recent report.

Recent data suggests the outlook for US activity has weakened further. While the recent initiatives by the Fed, including fostering market liquidity, may help mitigate the liquidity crunch, the situation is seen as far from stabilising, Chan notes, explaining why further monetary loosening is expected in the US.

However, Chan says that Hong Kong has no more room for further interest rate cuts, given that the savings rate has already hit the floor.

ôDespite inter-bank rates edging lower along with US rates, we believe it is very unlikely û if not impossible û for savings rates to decline into negative territory,ö Chan says. ôWe expect the Hong Kong dollar to stay at the strong side of the currency link, as the US and Hong Kong rate gap narrows on limited room for local rates to fall.ö

No unusual movement in funds has been observed despite significant volatility in the stockmarket, Chan notes.

The negative real interest rate situation will deepen when local inter-bank rates fall further, as the underlying domestic inflation rate reached 4.3% recently. This should lend some support to the local asset market amid growing uncertainty in the global financial market. While Hong Kong is facing fallout from the threat of a US recession, a lower interest rate environment should fuel domestic demand growth, which should help offset the anticipated slowdown in the external sector.

HSBC and other major banks in Hong Kong cut their benchmark lending rates last week to the lowest in three years, adding to the inflationary pressures that have been weighing on the Hong Kong dollar. HSBC reduced its prime lending rate by 50 basis points to a three-year-low of 5.25%.

The move came after a 75bp cut in the FedÆs federal funds target rate to 2.25% in a bid to help stave off a US recession. The federal funds rate, the interest that banks charge each other on overnight loans, was at 4.25% at the beginning of the year.