Sticky stuff

With Hong Kong’s headline inflation hitting a post-1995 high on a y-o-y basis, the question on everyone’s mind right now is: are we about to see runaway inflation? Moreover, as one of Asia’s most export-reliant economies, is Hong Kong inevitably heading into recession? The answer to both questions, in our opinion, is no.

Despite the strength of inflation, there is little evidence that rising prices have undermined household purchasing power as Hong Kong’s real retail sales numbers attest. On a sequential annualised basis, real retail sales (one of the closest proxies for Hong Kong’s real private consumption) are still expanding at roughly the same 25% (3m/3m, saar) rate as in 2Q11.

Despite the West’s increasingly grim growth outlook, buyers in Hong Kong continue to spend thanks to buoyant local consumption demand and tourist spending. That said, weakening Western demand is starting to weigh on business conditions and hiring activities. With consumers in the US and EU looking increasingly strained, Hong Kong’s export growth is set to be weaker in the second half of the year. Continued income growth, strong inflows of visitors from the mainland and government policies should all help to counterbalance this. But if inflation does not slow when Hong Kong’s  second key driver of growth, domestic consumption, could start to slip before the year is up.

Ironically, such an outcome could be just what is needed to bring inflation back down to earth, and for the economy to strike a more healthy macroeconomic balance. We continue to see inflation and financial market turbulence as the two top risks to the resilience of domestic demand.