Inflation likely to drop 2% in 2015-2016

While real rates could get less negative.

It has been observed that rising inflation but falling nominal rates had kept real interest rates sharply negative during 2008-14.

According to a research note from UBS, inflation is nevertheless easing, lifting real rates up despite nominal rates staying at almost zero.

UBS expects inflation to come down further, as imported inflation eases (thanks to subdued Chinese inflation, HKD strength and lower commodity prices) and rental inflation stabilizes.

Here's more from UBS:

Down from an average 4.5% the last four years, inflation could come down to 2.0%y/y in 2015-2016. This, plus the gradual rise in nominal rates as the Fed is expected to hike towards late 2015, suggest that real rates could become progressively less negative in 2015, and eventually turn positive in 2016.

Rising inflation and falling nominal rates had kept real interest rates sharply negative during 2008-14. This has been one of the key backdrops defining Hong Kong's accommodative monetary conditions the last few years.

Inflation is nevertheless easing, lifting real rates up despite nominal rates staying at zero since 2014. We expect inflation to come down further.

This, plus the gradual rise in nominal rates as the Fed is expected to hike towards late 2015, suggest that real rates could resume positive in 2016.