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Hong Kong UOB Economics Projections 2007 2008 2009F 2010F GDP 6.4 2.4 -5.0 3.5 CPI (average, y/y) 2.0 4.3 0.3 -0.5 Unemployment Rate (%) 3.2 3.8 6.2 5.8 Current account (% of GDP) 12.1 14.5 10.5 7.4 Fiscal balance (% of GDP) 7.5 0.1 -3.9 -1.6 Extending from its actions earlier, HKMA ratcheted up its interventions during 2Q09 to keep USD/HKD from hitting the lower bounds of the 7.75-7.85 peg range. Nevertheless, market participants are still sanguine on the outlook for the HKD, pricing in little change to the status of the peg over the next 12 months. We expect the HKD to continue to hover within the 7.75-7.85 range against the USD. HKMA in 2Q09 injected roughly a net HK$175bn to buy USD/sell HKD. This massive infusion of liquidity conditions has allowed the HIBOR to remain low. The rise in asset prices helps to offset the economic contractions. Among the beneficiaries are the property market, which saw transaction volume picking up sharply in 2Q. In tandem with this, mortgage loans volume has also accelerated. 1Q09 GDP should mark the worst point in the current cycle, as the HK economy contracted 4.3%q/q sa, worse than the -1.9%q/q pace in 4Q08 and the worst on record. We have cut HK’s 2009 forecast to -5.0% from -4.0% previously, and expect at lest another 3 more quarters of declines during the current year. Loose monetary policy and recovering asset prices, coupled with relatively healthy fundamentals, suggest that recovery in 2010 should remain on track, for a 3.5% growth. HKMA Ratcheting Up Interventions Extending from its actions earlier, HKMA intensified its FX interventions during 2Q09 to keep USD/HKD from hitting the lower bounds of the 7.75-7.85 peg range. Capital inflows into emerging markets including HK made a comeback in 2Q09 as low interest rates and loose monetary policy globally coupled with dissipation of extreme fears led to a revival of risk appetite. Nevertheless, market participants are still sanguine on the outlook for the HKD, pricing in little change to the status of the peg over the next 12 months. This was in contrast to earlier episodes when market participants back in 2004/05 (prior to RMB depeg) and around late 2006 (as RMB appreciated) were pricing in a break in the HKD peg. Currently, we see little risk of a change HK: USD/HKD Forward Prices HK: USD/HKD Trend HKD+3M Index HKD+6M Index HKD+12M Index 7.84 7.85 7.82 7.80 7.80 7.75 7.78 7.70 7.76 7.65 7.74 Jul 04 Jul 05 Jul 06 Jul 07 Source: CEIC, UOB Econ-Treasury Research 40 Quarterly Global Outlook 3Q2009 UOB Economic-Treasury Research Jul 08 7.60 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Source: CEIC, UOB Econ-Treasury Research Hong Kong in the status quo over the next 6-12 months, especially in view of the current synchronized downturn in global economic activities. With the global recession still taking shape, there is a low probability of a significant move on FX policy either from China or HK. Despite talks of a “super reserve currency”, there is clearly a lack of an alternative to the USD, and we see HKD peg to remain intact for now. As such, over the next 6 to 12 months, we expect the HKD to continue to hover within the 7.75-7.85 range against the USD. Monetary Policy Turning Easy As a result of the HKMA intervention actions, HK monetary policy has turned loose in tandem with the US Fed policy stance. Based on the change in Aggregate Balances, HKMA in 2Q09 injected roughly a net HK$47bn to buy USD/sell HKD, compared to a net withdrawal of roughly HK$100mn in 1Q09, to keep HKD from getting past the strong side of the 7.75-7.85 band. At the same time, HKMA also injected HK$128bn through Exchange Funds bills. This massive infusion of liquidity of about HK$175bn has allowed the HIBOR to remain low (with 3M HIBOR falling to as low as 0.33% in late May, the lowest since late 2004), which helps to offset the current economic contractions. This infusion of liquidity has helped to support assets prices and the property market is one of the key beneficiaries, which saw transaction volume picking up sharply in 2Q. In tandem with this, mortgage loans volume has also accelerated to levels last seen in early 2008 during the height of the previous property market run-up. Going forward, with the US Fed likely to keep interest rate low at least until 1H2010 (please see the US section in this report for further details), flush liquidity conditions in HK are likely to persist for some time, thus rendering further support to asset prices. Hong Kong: Property Transactions and Mortgage Volume HK: Property Transactions (LHS) HK: New Residential Mortgages Approved Number of S&Ps 35,000 30,000 16,000 14,000 25,000 12,000 10,000 20,000 8,000 6,000 15,000 4,000 2,000 Dec 00 10,000 5,000 Dec 02 Dec 04 Dec 06 Dec 08 Source: CEIC, UOB Econ-Treasury Research Economic Conditions Remain Challenging Amidst signs of stabilization globally, 1Q09 GDP should mark the worst point in the current cycle, as the HK economy contracted 4.3%q/q sa, worse than the 1.9%q/q pace in 4Q08 and the worst on record. On a y/y basis, top line figure contracted 7.8%y/y from -2.6% in 4Q, the second largest decline since the 8.1% fall in 3Q98 during the Asian financial crisis. As has been the case for other open economies, both domestic and external sectors contributed to the sharp declines, which saw HK: GDP Growth HK: Property Price and Labour Market Trend GDP Private Consumption Capital Investment HK Property Price Index (1999=100) HK Unemployment Rate: Inverted % (RHS) 200 HKD millions 20,000 18,000 0 160 2 120 4 80 6 40 8 15.0 10.0 %y/y 5.0 0.0 -5.0 -10.0 0 Jan 93 Jan 97 Jan 01 Jan 05 Source: CEIC, UOB Econ-Treasury Research 10 Jan 09 -15.0 -20.0 Mar 05 Mar 06 Mar 07 Mar 08 Mar 09 Source: CEIC, UOB Econ-Treasury Research Quarterly Global Outlook 3Q2009 UOB Economic-Treasury Research 41 Hong Kong domestic demand contracting 7.5%y/y in 1Q09 (same as in 4Q08), and exports collapsing nearly 20%y/y (from HK: GDP Growth Labour Force (mn persons) Unemployment Rate (%) - LHS 9.0 3.8 8.0 3.7 7.0 3.6 6.0 3.5 5.0 3.4 4.0 3.3 3.0 Jan 03 Apr 04 Jul 05 3.2 Oct 06 Jan 08 Apr 09 Source: CEIC, UOB Econ-Treasury Research 42 Quarterly Global Outlook 3Q2009 UOB Economic-Treasury Research about -4%y/y in 4Q08). One key indicator of the weak domestic demand is that headline jobless rate has spiked up in the current cycle. The jobless rate has climbed by 2.3%pt to 5.4% in the space of about 15 months. The extent of increase is similar to the previous two downturns in 1997/98 financial crisis and the 2000/01 tech bubble burst. Given the pace of increase, we expect the headline jobless rate to continue to move higher to 6% before the end of 2009, which would the highest level since early 2005. In view of the sharp drop in 1Q, we have cut HK’s 2009 GDP forecast to -5.0% from -4.0% previously, and expect at lest another 3 more quarters of declines during the current year. Loose monetary policy and recovering asset prices, coupled with relatively healthy fundamentals, suggest that recovery in 2010 should remain on track, for a 3.5% growth.