The Hong Kong economy grew by 3.5% year-on-year in the second quarter of 2018, following the 4.6% growth in the first quarter. The latest reading marked the seventh consecutive quarter of expansion above the trend growth rate of 2.7% per annum over the past ten years. For the first half of the year, real GDP was up by 4.0%, a figure that would likely be the envy of many other advanced economies.
In the second quarter, private consumption expenditure grew 6.1%, as a tight labour market with unemployment at a 20-year record low continued to support consumer sentiment. Looking at the GDP components in more detail, private consumption expenditure remained the main driver of growth, contributing 4.3 percentage points.
Overall investment spending in terms of gross domestic fixed capital formation rose by a modest 0.4%, down from the previous quarter’s 4.2%. This was largely due to a drop in building and construction activity, as major construction work on the Hong Kong-Zhuhai-Macao Bridge was completed in February. As a result, investment’s contribution to GDP growth fell from 0.9 percentage point in the first quarter to merely 0.1 percentage point in the second quarter.
While the headline growth remained robust, the fact that the year-on-year economic growth was roughly one percentage point off from the first quarter’s rate has raised concerns about the growth momentum. On a seasonally adjusted quarter-to-quarter basis, real GDP contracted for the first time since the first quarter of 2016, down 0.2% against a high base of comparison in the previous quarter, during which a stellar 2.1% growth was posted.
To gain a better understanding of where the domestic economy is heading and whether the growth slowdown in the second quarter is only transitory, we have tracked the trends of some economic indicators. These are the Hang Seng Index (HSI) and air cargo traffic, which have historically functioned well in detecting the turning points of domestic economic cycles; and money supply in terms of M3.
By mid-August, HSI had dropped more than 17% from its peak in January (Figure 1). The associated negative wealth effect from the financial market corrections and deteriorating sense of financial security may trigger weaker private consumption performance, which has been the main driver of our GDP growth. Meanwhile, a falling stock market would reduce the appeal of equity financing to firms, and thereby potentially weigh on their investments.
Last year, Hong Kong International Airport (HKIA) handled 4.94 million tonnes of freight, which accounted for 42%, or $3.44 trillion, of the total value of Hong Kong’s external trade. As such, air cargo traffic in Hong Kong can be considered a proxy for the activities of external trade and related sectors, and can be used to identify economic turning points (Figure 2).
The growth momentum in air cargo handled by HKIA had started to wane even before the China-U.S. trade war escalated in recent months, with growth peaking in early 2017. The trade war, which we expect to persist, may very likely exacerbate this slowdown in growth.
As to money supply, while Hong Kong does not use it as a target or instrument of monetary policy under the linked exchange rate system, it is worthwhile to follow its trend as part of our assessment, given its indicative power of fund flows.
Growth in the broad money supply M3 fell from double-digits in mid-2017 to 5% in June this year (Figure 3), with customers’ savings deposits with banks registering their first annual decline since December 2011. We should keep an eye on this dwindling growth in money supply, as it could be an early warning sign of deteriorating economic prospects.
The widening interest rate spread between the Hong Kong dollar and the U.S. dollar in the interbank market, and the resulting flow of funds from the Hong Kong dollar to the U.S. dollar, triggered action by the Hong Kong Monetary Authority (HKMA). In August, it intervened in the currency market for the first time since May by buying the Hong Kong dollar when it hit the weak-side Convertibility Undertaking of $7.85 to US$1 under the pegged exchange rate mechanism.
The aggregate balance – in other words, the sum of clearing account balances of commercial banks kept with the HKMA – has fallen from $179 billion at the beginning of the year to $92 billion as of 17 August.
As liquidity conditions tightened, local banks started to raise mortgage interest rates. Further rate hikes by the U.S. Federal Reserve – we expect two more in 2018 – will lead to the normalisation of local interest rates. This would no doubt pose additional negative impacts on consumer and investment sentiment.
Meanwhile, the recent weakness of the RMB could undermine the purchasing power of Mainland tourists, who accounted for 77% of all visitors to Hong Kong in the first half of the year. Over the past ten years, the average spending of overnight Mainland tourists has been highly correlated with the value of RMB (Figure 4).
This range of figures from different sources reinforces our view that Hong Kong’s economic growth will slow in the second half of the year and that the weaker performance in the March-June quarter is not transitory, but might well extend into next year.