23 April 2001

THANKS MR GREENSPAN, BUT CAN WE HAVE MORE?
Deflation continues to ease, but Hong Kong's real interest rates
remain historically high, despite the rate cuts so far this year.

The February rise in the deflation rate was a temporary, post-Lunar New Year phenomenon, with the March consumer price index figures, out today, showing a further easing in the deflation rate to -1.3 per cent from -2.1 per cent in February.

But the continuation of consumer price deflation - and deflation at an undoubtedly higher rate according to the yet-to-be-released broader measure of the GDP deflator - means that real interest rates still remain at relatively high levels in the SAR.

Recent cuts in nominal interest rates - two percentage points coming off the best lending rate since the beginning of the year - together with lower deflation, means that real (or deflation adjusted) interest rates have come down quite sharply. But they are still strongly positive compared with the negative "real" rates of the mid-1990s.

Based on the latest Composite CPI numbers, the "real" best lending rate is now below 9 per cent per annum compared with the peak of over 14 per cent reached back in 1999 and early 2000, when consumer price deflation was at its highest.

This should be positive for future levels of economic activity. However, with inflation anticipated to remain low, even as far as property prices are concerned, future expectations of real interest rates are that they will remain high in historical terms.

These future expectations of continuing slight deflation/ low inflation are probably an even bigger negative factor for current investment and purchase decisions than the actual level of real rates as indicated by the current inflation rates.

But at least the real cost of borrowing in the Hong Kong SAR has come down and with some further cuts in interest rates expected in the US - and a further moderating deflation locally - it should decline even further in the near term.

Even in the US, there is concern about the still high "real" level of interest rates and they are talking about two per cent inflation, not deflation, and a Prime Rate, or best lending rate of 7.5 per cent, the same as in the SAR. That's a real (inflation adjusted) rate of 5.5 per cent compared with the Hong Kong "real" rate of just under 9 per cent.

A further cut in interest rates in the US, courtesy of the Chairman of the Federal Reserve Board, Mr Alan Greenspan, would, therefore, be welcome in the SAR.

For further information, contact Ian K Perkin on 2823-1242.