When Hong Kong pegged its currency to the US dollar decades ago, least did it realize that any future trouble in the US economy will prevent the monetary authority of Hong Kong from putting its house in order. With inflation escalating, touching its highest level in ten years, the monetary authority of Hong Kong has no tools in its hands to arrest the soaring inflation.

Rise in food prices driven by supply constraint owing to the severe winter across mainland China on whom Hong Kong depends largely for its food supply has increased consumer price index by 6.3 percent in February that was much above the targeted 4.9 percent. With its dollar pegged to the US dollar, Hong Kong could not formulate any independent monetary policy, depending on the US Federal Reserve in determining its interest rate and consequent money supply.

However, Hong Kong’s economic cycle is not linked to the performance of the US economy, giving rise to unusual economic situations. The rising inflation is associated with falling interest rate in Hong Kong as Fed is successively slashing its rate of interest to salvage the US economy from an impending recession. With inflation touching 6.3 percent and the nominal rate of interest on mortgage loans being around 3 percent, the real rate of interest in Hong Kong is firmly negative. As a result, demand for new mortgage loans is spiraling upwards with 30 percent rise in mortgage loan approvals in January compared to last December. The property market in Hong Kong is witnessing a boom unlike USA where the sub prime crisis has spelt a doom for the real estate market.

The rising inflation in Hong Kong is largely a result of rising demand following a buoyant economic performance with four consecutive years of above the trend economic growth and a steady decline in unemployment rate. A weakening US dollar to which the Hong Kong dollar is linked, continuing appreciation in Chinese currency, rise in food prices, falling interest rate, booming real estate market pushing up property prices that in turn is being reflected in rising residential rents are on the whole showing that the rising demand without any possible monetary effort to arrest its growth will continue to fuel inflationary forces.

Source:ft
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