* Hong Kong dollar slumps towards weaker end of trading band
* Concerns of higher interest rates due to intervention weigh
* Interest rate swaps jump sharply
* Property and resources shares particularly hit (Adds background, recasts introduction)
HONG KONG, Jan 20 (Reuters) - Hong Kong’s stock market closed at a 3-1/2-year low on growing concerns a weakening local currency would force the central bank to tighten monetary policy, adding to the economic headwinds already buffeting the city.
The Hang Seng Index fell 3.8 percent to 18,886.30, its lowest level since late July 2012. The Hong Kong property sub-index slid 4.9 percent. All constituents in the benchmark index ended in the red.
Hong Kong stocks are already grappling with capital outflows and the knock-on impact of an unprecedented wave of intervention by the Chinese central bank to stabilise its the offshore yuan .
“Participants unloaded their shares as the Hong Kong dollar weakened further toward the 7.85 level,” said Steven Leung, sales director at UOB Kay Hian in Hong Kong.
“Investors unloaded the shares on concern over the continuous capital outflows and rising interbank rates.”
Interbank interest rates, an indicator of cash levels in the banking system, rose sharply, anticipating a potential squeeze in the money market.
Conita Hung, a director at Amicus Asset Management based in Hong Kong, said the weakness in the Hong Kong dollar is indicative of strong outflows from the market.
“After breaking below 19,200 points investors realised they can’t bet on a temporary bounce and there’s a lack of confidence in the market now,” she said.
The Hong Kong dollar fell for a fifth consecutive day to its weakest level in more than eight years, with a sharp drop in currency forwards suggesting more weakness was in store.
Some of the weakness in the Hong Kong dollar is due to proxy bets being taken on the local currency after Beijing rolled out an avalanche of measures to stem a selloff in the yuan overseas.
Meanwhile, capital outflows are another source of weakness for the currency.
On Wednesday, Asian stocks slumped to fresh four-year lows as a deepening rout in oil markets dealt a further blow to investor appetite for riskier assets.
In late afternoon trading, the local dollar fell to 7.8242 per U.S. dollar, its weakest level since August 2007 and just shy of a record low of 7.8305 in its 30-year old history of the currency board system.
Under the rules of the currency board, the dollar is allowed to fluctuate within a 7.75-7.85 band and central bank intervention is triggered if the currency hits either end of the band.
Looking ahead, investors see more cause for concern as a spike in interbank borrowing costs is tightening monetary conditions at a time when China’s economy is slowing.
Three month borrowing costs in the local dollar spurted to 55 basis points on Wednesday compared to 44 basis points at the start of the week, an unusually sharp move in the local money market.
Interest rate swaps tied to money market rates jumped. Three year swaps jumped to 1.73 percent from 1.18 percent on Monday.
“The spurt in the interbank rates is making investors nervous,” said the head of sales trading at a bank in Hong Kong. (Reporting by Saikat Chatterjee, Clare Jim and Donny Kwok; Editing by Sam Holmes)