Monthly Report on the Hong Kong Economy

Economic Analysis Division Economic Analysis and Business Facilitation Unit Financial Secretary’s Office

1.11.2007

The economy
The Hong Kong economy stayed in a good shape, virtually unscathed by the global credit market turbulence. Sentiment among consumers, businesses and investors remain positive. Retail sales registered another month of strong performance, while growth in exports remained notable on the back of the buoyant trade flows to and from the Mainland. Unemployment rate retreated again to the lowest in more than nine years, and businesses are still inclined in adding to their headcounts amidst expectations of business volume expansion. Local investment markets are benefiting from lower US interest rates, solid economic fundamentals in Hong Kong and the thriving Mainland economy (updated GDP and inflation forecasts for 2007 will be announced on 16 November).	The Hong Kong economy remains vibrant
The prospects of possibly slower global economic growth in 2008 would be a challenge for Hong Kong going forward given the economy’s characteristics as a small open economy. To solidify the foundation for continued economic development and improve the living environment, the Policy Address announced to push ahead with 10 large-scale infrastructure projects in the next few years. It is estimated that these projects, when reaching a mature stage, would bring about more than $100 billion of value added to the economy annually. Economy stayed vibrant amidst optimism among consumers and businesses	The Policy Address launched a number of initiatives to solidify the foundation for growth and development

The Domestic Sector
Retail sales rose 13.0% in September, the fourth consecutive month of double-digit year-on-year rise and picking up further from the 12.7% gain in August. Sales growth remained broadly based, supported by both strong domestic consumer spending and demand from inbound tourists, the number of which rose 15.9% year-on-year in September. Given the robust consumer confidence amidst the solid fundamentals in the local economy, domestic demand should continue to be a major driver of growth in the period ahead. Local consumer spending and inbound tourism were strong	A broad-based growth in retail sales under sustained consumer optimism
Value of retained imports of capital goods in September registered another month of decline due largely to a high base of comparison, while its real term counterpart has been fluctuating between positive and negative territories in the past few months. It is worth noting that capital goods intake could be volatile at times. Also, the Government’s plans for major infrastructure projects should provide a boost to local investment demand going forward. Trend in capital goods intake continued to be volatile	Prospects for the go-ahead of infrastructure projects should boost investment demand going forward
In fact, businesses in Hong Kong are generally optimistic about their operating environment in the third quarter, according to the latest Quarterly Business Tendency Survey conducted on large businesses across various sectors. In particular, significantly more respondents in wholesale and retail, restaurants and hotels and communications expected their business situation to improve further in the fourth quarter. On employment, about 50% of the companies surveyed in real estate and banks, financing and insurance expected to increase their headcounts. The positive sentiment in the business community should also have a bolstering effect on machinery and equipment investment.

The External Sector
The Global Environment
The concern over global economic growth for 2008 has heightened, as highlighted by IMF’s marking down their projection for global growth in 2008 by almost half a percentage point to 4.8% (versus a forecast of 5.2% for 2007) due to the financial turmoil that began this summer. It slashed its 2008 growth forecast for US by nearly a full percentage point to 1.9% and expected that the expansion across emerging Asia in 2008, while still robust, may moderate somewhat, reflecting slower trade growth as well as some policy tightening in countries facing overheating pressures.	Global growth is expected to slow somewhat in 2008
In the US, GDP for Q3 was 2.6% higher than a year ago, after growing by less than 2% in the first half, as exports jumped 9.6% year-on-year in the period and consumer demand held up rather well. On a quarter-on-quarter basis, the economy grew an annualised 3.9%, the biggest gain since 2006 Q1. In line with market expectations, the Federal Reserve cut its Target Rate by 25 basis points to 4.5%after the meeting during 30 – 31 October. The central bank expected that the rate cut, combined with the policy action taken in September, should “help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets.”	US: Sturdy exports perked up Q3 economic growth; Housing market remains a drag on the economy
However, the housing market remains a drag on the US economy, with housing starts in September being the lowest in more than 14 years, at 1.19 million units (annualised).
The European Commission lowered the midpoint of its GDP growth estimate for Euro Area, to 0.5% quarter-on-quarter in Q3 compared with an earlier forecast of 0.6% announced in September, citing record-high oil prices and rising borrowing costs. CPI inflation for the Euro Area rebounded to 2.1%, above the 2%-mark for the first time since August 2006. On the other hand, CPI inflation for UK in September was below Bank of England (BOE)’s 2% threshold for the third consecutive month. However, the market expects the BOE to wait for more evidence of easing inflationary pressure before contemplating an interest rate cut.	EU: Impact from earlier interest rate increases is surfacing
The Mainland economy continued to power ahead, growing by 11.5% from a year ago in Q3 after an 11.9% expansion in Q2. Fixed asset investment, which grew 26.4% year-on-year in the urban area for the first nine months of 2007, was still a major driver of the robust growth in the economy. President Hu Jintao, in his speech during the 17th party congress, set a goal of quadrupling the Mainland’s per capita GDP from year 2000’s level by 2020 through optimising the economic structure and improving economic returns while reducing consumption of resources and protecting the environment.	The Mainland: momentum in the economy persisted
CPI inflation in the Mainland for September cooled for the first time in the past five months, slowing slightly to 6.2% after the 6.5% rise in August. The rise in food prices decelerated somewhat to 16.9% year-on-year in September from August’s 18.2% jump as prices on items such as meat, eggs and vegetables rose at a slower pace. On the other hand, non-food prices increased 1.1% from a year ago in September following a 0.9% rise in August. Yet inflation remains a concern and is likely to trigger further tightening measures.	CPI inflation eased in September for the first time since April
The Japan economy has yet to be free of deflation concern, as the core consumer price index fell for the eighth consecutive month on a year-on-year basis in September, and the Bank of Japan again held its benchmark uncollateralised overnight call rate unchanged after its meeting on 11 October. Exports also grew at a slower pace, as the US market was sluggish.	Japan: Deflation lingers
Other Asian economies continued to demonstrate tremendous strength in Q3, as shown by the advance Q3 GDP growth figures from Singapore (9.4% year-on-year versus 8.7% in Q2) and South Korea (5.2% versus 5.0%).
US economy performed better-than expected in Q3; Asian economies stayed fairly robust
Crude oil prices set new highs again in October due to relatively low US crude oil inventories, further weakness of the US dollar and geopolitical uncertainty in the Middle East. Benchmark crude oil futures prices broke through the US$95-mark for the first time towards the end of the month. Oil prices continued to set record	Oil prices hiked further in October
Hong Kong’s trade performance
Merchandise exports recorded another month of fairly vibrant performance in September. Exports value increased by 8.5% in September from a year ago. Exports to the Mainland stayed strong and jumped 13.4% in September, while double-digit growth was also seen in exports to a number of emerging Asian countries. On the other hand, exports to US continued to be soft and dropped 2.0% on a year-on-year basis in September.	Buoyant trade flows to and from the Mainland continues to support Hong Kong’s export growth
The external trading environment has turned more uncertain following the recent global credit market turbulence, and the weakness of the US market is likely to continue in the coming quarters in light of the persistent weakness of its housing sector.Nevertheless, the strength in the Mainland economy should remain largely supportive to Hong Kong’s external sector. Moreover, the strong performance of other emerging markets, the sustained expansion of the EU market and the depreciation of the US dollar should help offset some of the adverse effect from the soft US demand. Exports to the Mainland remained the driver of Hong Kong’s export growth in September	Solid demand from other markets could offset some of the negative effect from weakness in US

The Property Market
Favourable economic environment, further improvement in households’ financial positions and expectations of lower interest rates lending further support to property market activities. Number of sales and purchase agreements registered during September stayed above the 10,000-mark for the sixth consecutive month, at 10 475. For residential properties, increases in sale price and rentals were noted across different classes in September with rentals for luxury flats showing distinct strength. Demand for residential properties firmed up further	Property market firmed up further under a favourable economic backdrop
Demand for commercial properties continued to be strong in September given businesses’ expansion plans, particularly for rentals of retail properties. Sale prices for both office and retail properties also registered notable increases during the month. Business expansion boosted demand for commercial properties

The Labour Market
Total labour supply dropped 11 400 between June – August and July – September as some summer workers returned to schools upon the start of the new academic year. Number of unemployed persons decreased in tandem by around 10 300 to 156 100 in July – September, while the number of employed persons also declined slightly by 1 200 even though the figure is still above the 3.5 million mark (at 3 502 200) in the period. Moreover, the year-on-year growth of employed persons, at 2.0% in July – September, continued to outpace that in labour force. Growth in employment continued to outpace that in labour supply Note: (*) Figures used are 3-month averages	Some summer workers returning to schools was a reason for the decrease in unemployment
The seasonally adjusted unemployment rate fell back again to 4.1% in July – September, the lowest level since mid-1998. The underemployment rate in the period declined marginally to 2.2% as well. On the back of sustained economic upturn and sanguine consumer sentiment, whether the unemployment rate could edge down further in the near term hinges on the pace of job creation relative to the growth in labour supply. Unemployment rate at its lowest level in more than nine years Note: (*) Figures used are 3-month averages	Unemployment rate retreated again on the back of the strong demand for labour

The Financial Market
The local stock market experienced another buoyant month during October. The Hang Seng Index closed above the 30 000-mark for the first time on 26 October, while turnover surged to as high as HK$210 billion on 3 October. The rosy sentiment among investors has been boosted by such factors as the possibility of more monetary easing in the US and prospects of additional capital inflows. The Hang Seng Index trended up further in October	Stock market continued its bull run
The Hong Kong dollar strengthened further against the US dollar during October, partly attributable to funds inflow relating to IPO activities. There was a strong demand for Hong Kong dollar assets. In response, The Hong Kong Monetary Authority (HKMA) operated within the Convertibility Zone and also the strong side of Convertibility Undertaking was triggered six times towards the end of October. Meanwhile, the effective exchange rate index for Hong Kong dollar fell again during October as the US dollar slipped further vis-à-vis other major currencies in the period given the market expected more interest rate cuts in the US. Hong Kong dollar effective exchange rate recorded further decline
HIBORs remained at a relatively high level during the early part of October amid frenzied stock market-related activities, with 3-month HIBOR higher than its Eurodollar deposit counterpart for the first time since late-2005. Consequently, a number of local banks had cut back the discount offered on mortgage loans after lowering their best lending rate in September. Whether the retail interest rates could trend lower will depend on the liquidity situation in the interbank lending market and the development in US interest rates. Interbank liquidity and US interest rates will dictate the direction of local interest rates	HIBORs remained high in early-October given the buoyant stock market activities
Hong Kong will relentlessly put efforts into building a diversified financial market to further consolidate its position as an international financial centre. In addition to facilitating Mainland enterprises and investors to participate in Hong Kong’s stock market and use the city as a platform for more outward investment, development of the RMB market and an Islamic bond market are other initiatives that were announced in the latest Policy Address.

Prices
The headline consumer price inflation figure held unchanged at 1.6% in September. Netting out the effect from rates concession, which covers the first two quarters of the 2007/08 fiscal year, the underlying CPI inflation was also steady at 2.7% in September. Dampening effect from the implementation of the Pre-primary Education Voucher Scheme and the smaller increase in prices of package tours helped offset the impact of higher food prices, which was to some extent caused by a seasonal rise around the Mid-Autumn festival that fell in September this year but in October last year.	CPI inflation held steady in September, but rise in food prices accelerated further
Going forward, the effect from the rates concession will fade out after September and the headline inflation rate is expected to go up in Q4 to reflect the underlying inflation situation in Hong Kong. Given the strength in the economy, higher food prices, appreciation in renminbi, the weak US dollar and the recent resurgence in oil prices are factors that could pose upside risks to inflation. However, the cut in public housing rentals in August and sustained rise in labour productivity will continue to help alleviate the upward price pressure to some extent. Headline inflation rate held steady in September but could move up in Q4 * Rate waiver starts to take effect	End of effect from rates concession would push up headline inflation rate in Q4

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