Thoughts on the upcoming “rate hike cycle” in Hong Kong

Hong Kong banks may raise their best lending rate in 2018, which would be the first hike for the Hong Kong “prime rate” in more than a decade. The aggregate balance of HKMA has been declining and the HKD exchange rate has been drifting towards the weak end of the convertibility undertaking, flagging HKD outflow pressure as the USD–HKD interest differential widens. Meanwhile, Hong Kong interbank rates have been trending up, signaling tighter HKD liquidity.

Given the more upbeat growth forecast for China and the US, the CICC macro team believes that the Hong Kong economy will continue expanding at a rapid pace in 2018. They expect Hong Kong real GDP growth to hold up at 3.6% YoY in 2018, notably higher than the current consensus forecast of 2.7% YoY. More specifically, their forecasts for consumption expenditure and external demand growth are more optimistic than market expectations.

Against the backdrop of strong aggregate demand growth, Hong Kong CPI inflation may pick up to 2.8% YoY in 2018, visibly higher than the current market consensus of 2.2% YoY and expected average CPI of 1.5% YoY in 2017. Consequently, Hong Kong nominal GDP may expand by 6.5% YoY in 2018.

The Hong Kong prime lending rate is expected to rise by 75–100bp throughout the course of 2018, while 3M HIBOR will likely reach 2.00–2.25% p.a. by end-2018. The team's more hawkish outlook for HKD interest rates is backed by their above-consensus growth and inflation forecasts for both the US and China, as well as their projection of a 100bp increase in the Fed funds rate for 2018.

The team does not expect rising interest rates to derail the asset reflation cycle in Hong Kong at this stage, as the overall financial conditions will likely stay loose―Hong Kong real interest rates may remain at a low level, while HKD effective exchange rates may depreciate against the backdrop of expected USD weakness in 2018. Meanwhile, higher HKD rates will likely lift the profitability of Hong Kong financial institutions, especially considering the low base and potential long way ahead for the rate hike cycle.

A potential downside risk to the Hong Kong interest rate forecast is if inflow pressure to Hong Kong turns out stronger than the already bullish expectations, in which case the Hong Kong asset reflation cycle will also become more pronounced than previously anticipated, including the reflation of property and equity assets.

Implications of Hong Kong Prime Rate hike on asset prices

The upcoming rate hike cycle would be of great significance to Hong Kong-based stocks and the local property market and may trigger rotation between different assets, sectors and styles. Analyzing the potential impacts of Prime Rate hikes on Hong Kong-based stocks should be helpful for mainland investors considering their growing interest in Hong Kong-based stocks.

In the last round of Prime Rate hikes (March 2005–March 2006), the CICC macro team found that:

► The economy maintained rapid growth and inflation rose moderately. Hong Kong’s GDP grew at an average rate of 7.7% YoY during the rate-hike cycle. CPI inflation rose moderately and averaged about 1.2% over the same period.

► Property prices continued to rise, although at a slower pace. The rise of the Prime Rate had an immediate impact on property prices in Hong Kong, but only slowed their pace of gain. The upward trend of property prices did not end until the global financial crisis in 2008.

► The Hong Kong dollar strengthened, as Prime Rate hikes widened the interest rate differential between Hong Kong and the US.

► Overseas capital flowed into Hong Kong, consistently attracted by improving economic fundamentals and corporate earnings.

► The stock market was slightly weak around the first Prime Rate hike (1-3 months) but maintained an upward trend driven by earnings growth; valuation declined initially. The Prime Rate hikes in 2005 did not have much impact on Hong Kong’s stock market. Improving corporate earnings provided key support for the market. Valuation was depressed initially, but expanded again in the mid to late stage of the rate-hike cycle.

► For Hong Kong-based stocks, value stocks outperformed growth stocks and there was not much difference in the performance of large-cap and small-cap stocks; the best-performing sectors shifted from consumer, industrials and utilities to financials, real estate and telecommunications. Hong Kong-listed Chinese stocks were more influenced by mainland China’s economic fundamentals and monetary policy.

Based on historical experience and considering current earnings growth and valuation, the team thinks that:

► Prime Rate hikes would not end the improvement in economic fundamentals and corporate earnings. At the initial stage of a rate-hike cycle, the economy and corporate earnings generally maintain strong growth and would not be significantly affected by rate hikes.

► The Hong Kong dollar may strengthen as the Hong Kong-US interest rate differential widens.

► While market sentiment may be affected temporarily, solid fundamentals will continue to provide support.

► Value stocks and the financial sector may benefit.

For more information, please refer to the reports Thoughts on the upcoming “rate hike cycle” in Hong Kong and Implications of Hong Kong Prime Rate hike on asset prices published in January 2018.