Hong Kong Seen Hit by China Slowdown, Fed Move on Rates in 2015

(Bloomberg) With an economy increasingly linked to mainland China yet a monetary policy still tied to the U.S., Hong Kong is set to be squeezed by diverging dynamics in the two nations, compounding challenges posed by political unrest.

The U.S. Federal Reserve yesterday reinforced forecasts for higher interest rates next year that would typically prompt Hong Kong to raise its borrowing costs. When the Fed was last tightening in 2004-06, Hong Kong’s economy was bolstered by surging growth in China. This time, China is contending with its weakest expansion in almost a quarter century, putting Hong Kong “between a rock and a hard place,” Nomura Holdings Inc. says.

“Slowing mainland Chinese growth will have a negative impact,” said Young Sun Kwon, a Nomura economist in Hong Kong. “Higher interest rates in the U.S. will result in higher interest rates in Hong Kong. That could be negative for Hong Kong property.”

Hong Kong’s economy was hurt this year by a moderation in Chinese growth and President Xi Jinping’s efforts to reduce corruption by officials. After an unexpected contraction in the second quarter, political unrest damped the outlook in the second half as pro-democracy protesters clogged the streets of key shopping areas in October and November.

Retailers in Hong Kong, a shopping hub for Chinese tourists thanks to luxury sales taxes on the mainland, have suffered. Sales of jewelry, watches and other high-end items fell for seven straight months through to August.

Forgoing Gifts

“There’s no more gift-giving with any business-related transaction” in China, said Adrienne Lui, an economist at Citigroup Inc. in Hong Kong. “This would most likely affect Hong Kong high-end retail sales again in 2015 and there’s no turning back in this trend at all.”

Retail spending may be hurt next year if further prolonged street protests take place, said Lui. “The chances of another trigger point that will cause another sit-in or another round of big protests could easily come in 2015.”

Property prices in Hong Kong may fall as much as 20 percent next year due to a weaker rental outlook and the potential for interest-rate increases, Alfred Lau, an analyst at Bocom International Holdings Co. in Hong Kong, wrote in a Dec. 17 report.

The city has fixed its currency to the U.S. dollar since 1983, meaning any change in American rates is typically followed in Hong Kong. In the last Fed-raising cycle, the Hong Kong Monetary Authority followed suit, putting pressure on property sales by the end of the period.

Fed Shifts

The Fed yesterday removed a pledge to hold U.S. rates near zero for a “considerable time,” following a strengthening in the job market and quicker growth in the world’s largest economy. While Fed Chair Janet Yellen said policy makers are unlikely to move in the January or March meetings, officials’ forecasts indicated most still see the first move coming in 2015.

Hong Kong’s connections with global trade mean that a stronger U.S. economy could cushion the impact of China’s weakening.

“The positive impact from a U.S. recovery may be able to offset the risk of slowing in China and Europe as Hong Kong’s growth remains more synchronized with the U.S. economy than the mainland,” Hong Kong-based Bank of America Merrill Lynch analysts Marcella Chow and Albert Leung wrote in a report this month.

Growth Impact

The economists forecast a 1 percentage-point slowdown in China’s growth detracting 1.06 percentage point from Hong Kong’s gross domestic product, while an extra 1 percentage point of growth in the U.S. economy would help Hong Kong’s GDP to expand by an additional 1.25 percentage point.

Hong Kong’s economy is forecast to expand 2.95 percent in 2015, according to the median estimate of economists surveyed by Bloomberg News, compared with 2.30 percent this year. The U.S. is set to expand 3 percent, after a 2.3 percent pace this year, while China will slow to 7 percent, from 7.4 percent this year, analysts project.

“Our base case remains for the Fed to hike rates in June 2015, which will be a headwind to the property market and hence domestic demand,” said Mole Hau, an economist at BNP Paribas SA in Hong Kong. “China is another key risk. Given the lack of monetary policy independence, it will be challenging for Hong Kong to regain competitiveness.”

Source: Bloomberg News by Lisa Pham