Housing inflation to remain high until 2H12

First, the relatively good news on inflation. We think imported inflation—a major source of inflation in Hong Kong—has peaked, reflecting the moderation in global commodity prices and Chinese inflation. This is important. Imported items, the tradeables constitute almost half of the CPI basket in Hong Kong, and thus the easing of which will help, at least, stabilize headline inflation.

But the not so good news is housing inflation will stay elevated for a while, as the lagged impacts of rising property prices continue to filter through. As we pointed out in our earlier piece, the pass-through from asset inflation (rising property prices) to consumer inflation is both strong and direct in HK, unlike most of its Asian counterparts.

The pass-through works in the following sequence: rising property prices will drive housing rental higher and higher rental would then be reflected in the CPI housing component with a time lag. The time lag reflects the fundamental difference between the rental index and CPI housing costs. While the rental index is a measure of spot rent (including new lettings only), the CPI is a measure of average rent (including new, renewed and continued lettings).

In other words, even if spot housing rental decline over the next two quarters, housing inflation will remain stubbornly high until 2H12, when the impacts of the rental contracts negotiated during the rental up-cycle increasingly wear off. For instance, if we assume a total of 10% residential rental decline over the next 2 quarters, (as a comparison, rentals declined 20% from peak to trough in 2008’s global financial crisis), housing CPI will continue to climb and likely peak at near double-digit rate in 4Q11. Beyond the peak, housing CPI could continue to linger above 5% until 2H12.