Headline PMI eased to 53.7 in February 2011

February new orders fell to 54.1 from 58.1 in January while February employment index jumped to 52.6 compared to 51.1 in January.

According to HSBC's Economist, Donna Kwok, Hong Kong's private sector joined most of Asia in easing its foot off the accelerator pedal in February to celebrate the Chinese New Year. That said, no acceleration doesn't mean no expansion. The private sector still showed signs of solid improvement - especially for job creation and wage increases, so underscoring our buoyant outlook for consumer spending and GDP growth (+5.2%) this year. The continued tightness of productive capacity (backlogs of work built up for the seventh straight month) and the second straight month of positive job creation suggest that businesses remain upbeat.

February's headline PMI cooled to its lowest in three months at 53.7 (Dec: 55.2), but stayed comfortably above the 50 threshold. Hong Kong's private sector expanded for the nineteenth straight month last month. New order intakes continued to rise from January (Feb: 54.1; Jan: 58.1), but at a relatively slower pace due to a weaker increase in new Mainland orders (Feb: 51.3; Jan: 53.6). The output sub-index subsequently eased to 54.9 in February, versus 57.8 previously.

As our Chief China economist Qu Hongbin notes, China's softer growth momentum in February can be traced back to distortions associated with the Chinese New Year and the impact of Beijing's recent monetary tightening and fiscal stimulus withdrawal. Although he expects Beijing's on-going tightening measures to continue filtering into the Chinese economy at a modest pace in the coming months, the Chinese New Year distortion's done for this year.

Taking into account this CNY bias, coupled with the super strong result delivered by the US ISM survey yesterday, despite a softer reading, the overall global growth picture for Hong Kong in February was arguably more positive than negative. The new order minus inventory gap for February's US ISM survey hit its highest in over a year, while that for Hong Kong and China both remained in respectably high territory despite the CNY effect.

In the meantime, on the inflation front, the pass-through of spiraling input costs into output prices continued to pick up pace. Both the input and output cost sub-indices increased markedly in February, printing 67 (Jan: 71.1) and 57.2 (Jan: 56.1) respectively. Rising wages, raw materials and plastics costs and unfavorable exchange rate moves all fueled input cost inflation, coaxing more businesses to pass on the cost burden to consumers - which in turn sent the prices charged sub-index to a level well above its long-run average.

That said, wage inflation doesn't have to be all bad. Survey respondents attributed above-trend wage growth to the strength of recent company performance. In other words, strong growth is enhancing HK businesses' ability and/or willingness to pass on higher input costs to consumers.

Taking the differential between the output and input cost sub-indices as a proxy for corporate profitability, it can be argued that margins for Hong Kong businesses improved again for the second consecutive month in February.

Hong Kong's private sector continues to expand at a solid pace, despite softer Mainland demand likely caused by Chinese New Year distortions and the gradual filtering through of Beijing's monetary tightening measures. Going forward, a brightening US manufacturing outlook should help to counter the impact of cooler (but still elevated) levels of Mainland growth. Wage growth will continue to fan inflationary pressures alongside rising global commodity prices, especially as businesses become increasingly willing to pass on cost burdens to their customers.