13 June 2018
Hong Kong reflation cycle may have more legs to run


Hong Kong real GDP growth accelerated notably to 4.7% YoY in 1Q2018 from 3.4% YoY in 4Q2017 and 3.8% YoY last year. More impressively, HK nominal GDP growth leaped to 9.1% YoY in 1Q2018 from 6.8% YoY last year. Meanwhile, inflationary pressure in Hong Kong has been building up rapidly, including that of asset prices and more recently, consumer prices.

In our view, the ongoing Hong Kong reflation cycle may have more legs to run. We raise our already above-consensus HK GDP forecast of 2018 to 5%, and we now expect HK nominal GDP growth to reach 8-9% in 2018, up from 6.8% in 2017 and 3.9% in 2016. In our view, the combination of surging nominal growth and highly-accommodative monetary conditions in Hong Kong indicates further upside for growth and inflation:

The much stronger domestic consumption demand and the inflow of mainland visitors this year may prove to be more sustainable than market expects, given our forecast of a more resilient cycle in China and a weaker USD over the medium term. It is worth noting that the growth of average mainland consumers’ “purchasing power” in HKD terms accelerated by 25ppt between 1Q 2016 and 1Q2018, a pace only seen in 2005-07.

Monetary conditions in Hong Kong may have loosened in the past year despite strong reflationary impulse, including that of asset price reflation. Consequently, Hong Kong will likely be set up for more inflation upside due to its unique monetary policy regime.

Real interest rate is still declining and may stay low for longer despite potential rate hikes.

Robust nominal growth, rising inflationary expectations, and lagging monetary policy adjustments (by design of the currency board regime) point to potential “over-shoot” of inflation to the upside, especially that of asset prices.

At this stage, the upcoming prime lending rate hike(s) in Hong Kong is well-anticipated. Rising rates may help introduce some (much-needed) monetary tapering, but the pace of rate hikes will unlikely be enough to spoil the domestic demand and asset price reflation cycle any time soon -- as the increase in interest rate may continue to lag the pace of rising inflationary expectations, meanwhile, the HKD may stay relatively weak vs. the currency its biggest trading partner – the CNY.