Economic Insights
Get Ready for Interest Rate Rises
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US employment chart

HKSAR Consumption chart

Borrowing costs chart

Interbank rates in Hong Kong chart

Hang Seng Index chart

The rising cost of borrowing in 2018 may dampen consumption growth and result in slower economic growth for Hong Kong compared to 2017.

Hong Kong is expected to follow the United States and start raising interest rates this year. This will erode the purchasing power of the city’s homeowners and could restrain growth momentum. 

The U.S. rate rises come amid resilient economic trends. GDP grew 2.2% year-on-year through the first three quarters of 2017 in the U.S., while stronger business investment and consumer sentiment have also supported the world’s largest economy. 

Profits of U.S. corporates remained solid, representing 11.4% of the country’s GDP in the third quarter. Overall corporate profits improved 5% YoY through the first three quarters of 2017, with domestic industries and overseas businesses growing 3.2% and 12.8% YoY respectively. 

The private sector in the U.S. added an average of 170,400 jobs per month through the first 11 months in 2017 (see Chart 1), while the unemployment rate was at 4.1% in November – the lowest level since December 2000. The employment market remains buoyant, boosting consumer and business sentiment across the board.1 

Investors’ inflation expectation has edged higher, with bond yields of two-year treasury bonds reaching 1.94% on 3 January, picking up some 72 basis points from a year ago. 

Improved sentiment supporting Hong Kong
In Hong Kong, after considering much of the available data, we expect the economy’s YoY growth for 2017 to be 3.7%, driven primarily by improving domestic consumption. 

On the back of the increasingly tight labour market, wages have been rising. In November, the unemployment rate stood at a 20-year low of 3%. At the end of the third quarter, median and average wages grew 3.3% and 3% YoY respectively.2

Wage growth, together with the negligible inflation in 2017 (1.5% YoY), has encouraged a more optimistic outlook. According to a Chinese University of Hong Kong survey, there has been a sustained and broad-based improvement in consumer and employment sentiment (see Chart 2). 

Together with the moderate expansion of inbound tourism, these trends have buoyed retail sales growth, which recorded in 2017 a slight YoY improvement for the first time in four years. Through the first 11 months of 2017, retail sales grew 1.8% YoY, after dipping 8.1%, 3.7% and 0.2% in 2016, 2015 and 2014 respectively. 

So long as Hong Kong maintains its buoyant labour market conditions and attractiveness as a tourist destination, we expect consumption growth to continue to buttress retail-related sectors.

Hong Kong’s economic environment has long been subject to the externalities of international markets. Given the linked exchange rate system, local interest rates will rise as the Federal Reserve continues to push U.S. rates upwards. 

Although local commercial banks have held prime lending rates unchanged to date, the aggregate balance of Hong Kong’s interbank system has been declining (see Chart 3). This could be a result of money moving from Hong Kong to markets with higher interest rates. As the additional liquidity in Hong Kong’s banking system dries up, prime lending rates may begin to rise towards the latter part of 2018. 

In fact, interbank lending rates (HIBOR) have already been escalating, with one-month and three-month HIBOR reaching 1.1% and 1.3% in late December 2017, compared to 0.4% and 0.8% in June 2017 (see Chart 4). Since almost all recently approved mortgages made reference to HIBOR, the higher interbank rates have arguably eroded the purchasing power of homeowners. This could, in our view, become a drag to growth momentum in 2018.

Looking ahead, any decision by the Fed to accelerate the tapering of its quantitative easing programme could agitate financial markets. The performance of the Hang Seng Index is highly correlated with Hong Kong’s GDP and consumption growth patterns, so any turbulence in financial markets would drag the economic momentum down (see Chart 5).

With interest rate hikes on the horizon, we maintain our stance that Hong Kong’s GDP growth will be within the range of 2.5-3.5% YoY in 2018, slightly lower than the 3.7% expected for 2017. 

Referring to CEO Economic Outlook Index, Sentix Economic Indicator, Economic Optimism Index, Small Business Optimism Index, Consumer Sentiment Index, and Johnson Redbook Index
2 Average wage for employees up to supervisory level was used as a proxy.


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