"The consequences of targeting a fixed exchange rate are that Hong Kong has relinquished control over its monetary policy to the United States, while its domestic costs and prices have had to bear the full brunt of adjustment to external shocks," says the bank. "These limitations have become more obvious over the past five years, particularly in the current economic cycle, in which Hong Kong is the laggard in the region."

Markets have been particularly sensitive on the subject of the peg since Ho Cheuk-yuet, head of research and strategy at Bank of China subsidiary BOCI Research, was quoted in September as saying the peg should be abolished. People took this to be somehow a statement on behalf of the Chinese government.

Since then there have been two market scares, both eliciting firm denials from Financial Secretary Antony Leung Kam-chung that the Government was considering a change. However, on the second occasion Legco was driven into abandoning a study of the subject which had been proposed by Frontier legislator Emily Lau Wai-hing and endorsed by other Financial Affairs Panel members in July. A Panel meeting voted unanimously to shelve the project. "The market has had a strong reaction to the news of the study on the peg, and we should ask the division to suspend the work immediately," said legislator Eric Li Ka-cheung, who called the vote.

The peg is wisely seen as exacerbating the deflation which has hobbled the SAR's economy recently; but Lehman's report said it was unlikely the government would abandon the peg in the near future.

Long term, economists see it as almost inevitable that the peg will have to be surrendered to Hong Kong's growing financial integration with mainland China, and Lehman says that the pain of the change would be less if it was made sooner rather than later. "The longer that price deflation persists, the greater the negative effect on the real economy."