HONG KONG, June 12 (Reuters) - Hong Kong's financial markets came under pressure on Wednesday, with stocks falling and demand for cash surging, as protests against the territory's controversial extradition shut down key parts of the city.
Tens of thousands of demonstrators stormed main roads next to government office, protesting local officials' efforts to push ahead with a legislation that would allow people to be sent to mainland China for trial.
The benchmark Hang Seng Index gave up 1.6% in the morning session, while Chinese companies in Hong Kong slid 1.1%, compared with losses of less than 0.6% losses in Shanghai and Asia ex-Japan.
The selloff comes amid broader concerns about the global economy, a key driver of growth in the former British colony, as Sino-U.S. trade tensions worsen, and expectations about a U.S. Federal Reserve rate cut in the months ahead.
Ben Kwong, director of research at KGI, said local stocks were due to give up some of their gains after a few strong sessions, and that the protest was an excuse for the market to adjust.
"This is a normal initial reaction, when you have social unrest or tension, given that we've had a few years of relative calm," he said.
But it also sent financial institutions scrambling for liquid assets with interbank interest rates in the city shooting up across the curve . One-month and two-month HIBOR reached their highest since late 2008, while the one-week tenor jumped 87 basis points.
As a result of the higher interbank rates, the Hong Kong dollar rose 0.2% to 7.8208 per dollar, its strongest since last December.
The Hong Kong dollar is pegged to the greenback at a range of 7.75-7.85. Official interest rates in Hong Kong usually move in lockstep with the Fed.
Interest rates are usually higher and liquidity tight during the mid-year dividend season and when there are large listings in the local stock market.
But two forex analysts based in the city said the protests added pressure, heightening concerns about capital outflows.
"This time around, people are really concerned about political risks, worried about foreign capital leaving Hong Kong," said one of the analysts, who asked not to be named.
In September 2014, when the 79-day "Occupy" protests broke out, the local currency and stock market weakened initially but rebounded in the following month, while the HIBOR curve sat below 1%.
Back then, however, global growth was strong enough for the Fed to hike rates and move away from interest rates that were near zero percent. This year, markets expect the Fed to cut rates amid concerns over growth and intensifying trade tensions.
As such, local markets may react differently to the social upheaval given the risks of lower rates locally, said Alex Wong, director at Ample Finance in Hong Kong.
"The impact was short lived in the past. But now we're in bear market. Sentiment was not good before this," he said.
Fitch affirmed Hong Kong's AA+ credit rating on Wednesday, citing strong public finances and resilient economy.
But the rating could come under review if there is "a move towards greater alignment of institutional and regulatory frameworks that diminish the autonomy of Hong Kong with respect to the factors that support its higher credit rating relative to mainland China," the agency said, commenting on the extradition bill.