Double whammy: Price hikes and wage inflation soften local demand

Facts
All sub-indices that matter for Hong Kong growth barring new orders expanded in June. Output continued to rise, as did new orders received from China, allowing staffing levels to rise at an even faster pace than before. Staffing costs - which have risen non-stop for almost two years - are still rising at an above-trend rate, adding to the burden of higher input prices for businesses. Demand from local businesses softened as a result, leading to the first contraction in the new orders index since June 2009.

Operating conditions expanded at their slowest pace in 23 months in Hong Kong, as the headline PMI index eased to 50.3 from 52.2 previously. New orders contracted on the month for the first time since June 2009 (49 compared to 54 a month earlier). The "new orders minus inventory" ratio dipped into the red as a result, printing -0.8 versus +7.7 previously. Although the decline was marginal, it was nonetheless unexpected as both China's manufacturing and non-manufacturing PMIs (HSBC) stayed above 50 in June.

Survey respondents flagged cooler local demand as the key reason behind slower new business inflows. This was supported by the fact that the new China business sub-index continued to expand in June (51.7), albeit at a slower pace than before (May: 58.2). Nonetheless, it was sufficient to keep overall business activity rising, with the output sub-index printing 51.3 (May: 54.7).

The double whammy presented by escalating raw material prices and higher wage inflation likely spurred the softening of lcoal demand this month. Although June's input cost index eased for the first time since February, at 65.5 it is still sitting high above trend (59.3), so cost inflationary pressures remains acute. To protect profit margins, businesses passed through a higher proportion of input cost increases to final consumers as well. The differential between the output and input cost sub-indices picked up for the second consecutive month (to -6.8 versus -10.8 previously), while output prices charged to final consumers stayed above trend (53.5), printing 58.9.

The silver lining to be taken away from this mixed picture is that both employment levels and wage growth remain robust, helping to counter (though not fully neutralize) the erosion of local purchasing power by inflation. Despite slowing new order inflows and the recent introduction of the new minimum wage, the employment sub-index rose again for the sixth month running. This is promising, and suggets that (1) businesses expect the dip in local demand to be temporary and (2) the new wage legislation has not derailed Hong Kong's job market recovery so far.

Bottom-line: Like the rest of Asia, Hong Kong is coming to grips with escalating inflation alongside turbulence in the global trade cycle. Rising prices has started to cool local demand, but robust employment and wage growth are counterbalancing, to an extent.