The scramble to lure retail money marks a change for the city's banks, most of which have kept deposit rates on hold this year even as the U.S. Federal Reserve pushed rates up aggressively.

Nearly a dozen Hong Kong banks, as Dah Sing Bank, China Citic Bank International and China Construction Bank (Asia), have raised deposit rates over the past two weeks. Some of them are offering 3.9-4% per year on three-month deposits, a level last seen in late 2022.

Analysts said the trigger was the sharp fall in banking system liquidity. The aggregate balance at the Hong Kong Monetary Authority (HKMA) has fallen to its lowest since 2008, as the central bank intervened to defend its currency peg.

"As the aggregate balance has fallen to HK$45 billion, banks now expect that interbank rates will only go up as the demand for the Hong Kong dollar is rising as the economy improves," said Samuel Tse, an economist at DBS Bank.

Hong Kong's main policy rates are tethered to those in the United States by the currency's peg to the dollar, but the city's interbank rates were pinned to lows by weak loan demand and investment inflows into Chinese stocks and bonds.

The spread between Hong Kong and U.S. rates hit its widest in two decades in April, as banks cut their deposit rates and investors borrowed the cheap Hong Kong dollar for carry trades.

But banks are now seeing interbank rates rise as loan demand picks up and international appetite for Chinese assets cools. The one-month Hong Kong Interbank offer rate (Hibor) climbed 165 basis points in just a month to around 4.45%.

The city's economy grew 2.7% in the first quarter aided by a recovery in inbound tourism and domestic demand. It was the first quarter of growth after four consecutive ones of contraction. The number of mortgage loan approvals in Hong Kong also rebounded strongly in the months of February and March.

To be sure, banks can borrow against the HK$1.2 trillion ($152.89 billion) they hold of exchange fund bills, which are debt securities issued by the HKMA, to get quick cash from the monetary authority's discount window.

But raising money from retail depositors is the cheaper option. The HKMA discount rate for repurchase transactions follows the city's base rate, and is around 5.5%.

($1 = 7.8489 Hong Kong dollars)

(Reporting by Georgina Lee; Editing by Jacqueline Wong)

By Georgina Lee