Hong Kong Economic Update

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1 Irina Fan Senior Economist Joanne Yim Chief Economist May 28 Hong Kong Economic Update Hong Kong s March export growth stayed low at 7.6 yoy, as exports to the mainland showed no growth. Taking the first three months together, however, total exports still grew strongly by.9 yoy. Despite the fact that the US economy is at risk of slipping into recession, Hong Kong s exports were underpinned by steady demand in the EU and Asia. Looking ahead, with the stagnant US market having already dragged down Mainland s export growth to 21.3 yoy in 1Q8, from 25.7 in 27, it would be difficult for Hong Kong s exports to maintain its impressive performance. On the domestic front, the labour market remained relatively tight, but has been lackluster in adding new jobs. The March unemployment rate edged up to 3.4, from 3.3 in February, due to a drop in total employment. The momentum of job creation looks set to slow as signs of cooling demand become more apparent. The trade sector was the first to feel the pain and the heightened risk in the global credit market also impaired worker demand from the local financial services sector. Domestic demand remained supported by rising wages with March retail sales growing 2.2 yoy in value and 13. in volume. However, the upside surprise was mainly due to rising prices as the gap between the value and volume growth widened from four to five percentage points in the last few months to seven percentage points in March on elevated food and energy prices. March CPI inflation eased to 4.2 yoy, from 6.3 in February, due to property rates concessions. Taking out this factor, the underlying inflation crept up to 5.3 from 5.1 in the previous month on high food prices. The inflation spike is likely to have peaked, but the pace of easing will depend on how fast food supply can re-adjust. At this stage, we still see a relative mild inflation rate of 3.5 for the full-year of 28, as signs of cooling demand are becoming more apparent. Nevertheless, the elevated global food and energy prices pose upside risk to inflation.

2 Retail Sales Value Inflated by Soaring Prices March retail sales figures were impressive, surging 2.2 yoy in value and 13. in volume. The sales volume indicates consumer spending stay robust, but the upside surprise in the value of sales was due largely to rising prices. The gap between the value and volume growth widened from four to five percentage points in the last few months to seven percentage point in March on elevated food and energy prices, similar to trends discerned in the CPI readings. While the volume growth of food sales was stagnant, its sales value climbed Fuel volume rose 4.7, the value was inflated to a 26.7 growth. Looking ahead, retail sales are likely to stay strong in the near term, as consumer confidence is underpinned by rising wages and good employment prospects. The March unemployment rate, even though it edged up slightly to 3.4, remained at a -year low. Latest survey also indicates that salary increases in 1Q8 were larger than that in 4Q7. Nevertheless, signs of cooling demand are becoming more apparent, as can be seen in the latest export figures. Retail sales growth is likely to decelerate gradually in line with the slower momentum of the economy. For the year as a whole, we still expect a decent growth of 14.7 for retail sales in value terms, but creeping retail prices also imply that growth in real term may be less impressive. Exhibit 1 : Hong Kong Retail Sales (Mar8) Exhibit 2 Value Volume All retail outlet tobacco Food, alcoholic drinks & Supermarket Fuel clocks & valuable gifts Clothing & footwear Department stores Consumer durables Jewellery, watches, Other consumer goods Source: Census and Statistics Department Hong Kong Retail Prices Source: Reuters EcoWin 2

3 Exports Below Expectations Hong Kong s March export growth stayed low at 7.6 yoy, as exports to the mainland showed no growth. Exports to the US were surprisingly strong, up.5, whereas shipments to our Asian neighbours slowed. Monthly data tend to be volatile. Taking the first three months together, total export growth rose.9 yoy, faster than the 8.2 growth recorded in the 4Q7. Thus far, consumers in the EU and Asia have been able to make up for waning demand in the US. However, it is highly uncertain that the strong trade growth with the rest of the world can be sustained amid a sharp slowdown in the US, as a substantial part of intra-regional trade involves shipments finally targeting the US and European markets. The latest data point to softening economic activities in the euro zone. Mainland s export growth has already eased to 21.3 yoy in 1Q8, from 25.7 in 27 dragged by a stagnant US market, which may be an early warning. We believe Hong Kong cannot opt for a different path. We keep our view that total export growth in 28 is to slow to 7.2 yoy, from 9.2 in 27. Exhibit 3 : Hong Kong Trade Statistics Exhibit 4 Mar8 Feb8 Total exports (HKD bn) Domestic exports 7 6 Re-exports Imports (HKD bn) Total exports (yoy ) Domestic exports Re-exports Imports (yoy ) Source: Census and Statistics Department yoy Mainland and Hong Kong Exports to the US Hong Kong (3MMA) Mainland(3MMA) yoy Source: CEIC 3

4 Higher Unemployment Rate on Job Cuts Hong Kong s unemployment rate edged up slightly to 3.4 from 3.3 in the pervious month. Higher unemployment rates were mainly observed in the decoration and maintenance, communications and restaurants sectors. While labour market conditions remain relatively tight, but the sector has been slow in adding new jobs. Total employment declined 6,4 in March after a drop of,2 in the previous month. The figures might be affected by seasonal factors associated with the Lunar New Year festivals, as there is often job cut after the festival. The momentum of job creation looks set to slow as signs of cooling demand are more apparent. The trade sector was the first to feel the pain of waning global demand and has been lack-lustre in adding new jobs for months. The heightened risk in the global credit market and the recent corrections of local stock market also impaired demand for workers from the financial services sector, which has been one of the major drivers for creating new jobs in recent months. Job opportunities will probably come mainly from the retail and hotel sector, as domestic spending remains strong and tourist numbers are also on the rise. Overall, we see unemployment rate bottom out and will continue to rise in a gradual manner in coming months to reach an average of 3.8 for the full-year of 28. Exhibit 5 Unemployment Rate & Job Creation (') New employment Unemployment rate (s.a.) Source: CEIC Exhibit 6: Hong Kong Source of Job Creation Overall Import & export trades May 7 13, 14, Jun 7 9,9 9,5 Jul 7 9,2 5,3 Aug 7 9,2-2,9 Sep 7-1,2-6,9 Oct 7-6,8-8, Nov 7 12,2-3,3 Dec 7 25,7 3,9 Jan 8 17,2 - Feb8 -,2-5 Mar8-6,4 n.a. Source: CEIC, Census and Statistics Department 4

5 Subdued Inflation on Property Rate Concession March consumer price inflation eased to 4.2, from 6.3 in the previous month. Again, the one-off property rate concession for 1Q8 continued to have the impact of lowering headline CPI readings in March. Taking out this factor, the underlying inflation rate crept up to 5.3 against a rate of 5.1 in February. The upsurge of food prices remained the main culprit. Food prices (excluding meals bought away from home) soared 17.2 yoy in March, slightly lower than the 19.5 surge in the previous month. The food price sub-index also seems to have stabilized. Nevertheless, the CPI readings are likely to stay high in coming months, as food prices will only ease slowly on elevated global agriculture prices and the extended food supply adjustment time after the Mainland snowstorms. Rising global oil prices also exerted upward pressure on local utilities prices, which have been rising at around 7 for three consecutive months. The inflation spike is likely to have peaked in February. But the pace of easing will depend on how fast food supply can re-adjust. At this stage, we still see a relatively mild inflation rate of 3.5 for the full-year of 28, as signs of cooling demand are becoming more apparent, which is likely to put a dent on inflationary pressure. Nevertheless, the elevated global food and energy prices pose upside risk to inflationk. Exhibit 7 Exhibit 8: Hong Kong Composite CPI Component, yoy Mar8 Feb8 All items Food.2.8 Meals bought away from home Exclude meals bought away from home Housing Electricity, gas & water Alcoholic drinks & tobacco.4.9 Clothing & footwear 3..6 Durable goods Miscellaneous goods Transport Miscellaneous services Source: CEIC, Census and Statistics Department 5

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7 Hong Kong Property Prices Hong Kong Office & Retail Rentals Index Private domestic (less than 4m2) Private domestic (16 m2 or above) 9 7 Index Source: CEIC Office rentals Retail rentals Source: CEIC 7

8 Hong Kong Economic Monitor Statistics May 28 yoy() yoy() yoy() HKD bn yoy() HKD bn yoy() yoy() yoy() , , , , , , , , , , , , F 5. NA ,542. 3, Q NA 5.9 4, , Q4 6.6 NA 6.3 4, , Q NA 6.6 4, , Q2 6.4 NA 7.9 5, , Q3 6.3 NA , , Q4 6.6 NA , , Q1 28 NA NA ,762 3, Nov 27 NA NA , , Dec NA NA , , Jan 28 NA NA , , Feb NA NA 4.5 5, , Mar NA NA 13. 5, , YTD NA NA , , balance HK$bn yoy() HK$bn yoy() HK$bn yoy() yoy() ' yoy() 22 1, , , , , , , , , , , , , , , , , , F 2, , , Q , Q , Q , Q , Q , Q , Q , Nov , Dec , Jan , Feb , Mar , YTD , Note: (F) Forecast GDP (real) Exports Source: CEIC, Hang Seng Bank Real GDP per capita Retail sales (real) Foreign Trade Imports Total Deposits Trade Property Price Index Total Loans Office Rental Index Money supply (Total M3) Consumer prices Tourist Arrivals Unemployment rate (s.a.) HKD per USD (end of period) 8

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Upside Risk to Inflation and Downside Risk to Growth

Irina Fan Senior Economist irinafan@hangseng.com Joanne Yim Chief Economist joanneyim@hangseng.com July 28 Upside Risk to Inflation and Downside Risk to Growth The economic landscape has changed significantly