In its latest statement, the US Federal Reserve has not given a clear indication as to when it will start raising interest rates, but the market believes the “lift-off” is coming closer.
As a result, the US dollar index has rebounded, and US stocks also moved up.
The Fed said in the statement that household consumption and the housing market are improving, although the inflation has yet to meet its 2 percent medium-term target amid lower commodity prices.
The central bank said it only needs to see “some” more improvements in the labor market to make it more confident that inflation will rise.
“Some” has never appeared in its previous statements, and as such, the market believes the Fed is on track to hike interest rates within this year if employment data continues to improve in July and August.
The mounting expectation for a rate hike will push up US dollar further. That could harm the competitiveness of Hong Kong as its currency is pegged with the greenback.
In fact, the real effective exchange rate of China and Hong Kong has surged 20 percent between late 2011 and June 2015, according to data from the Bank for International Settlements.
The real effective exchange rate measures the real value of a country’s currency against the currencies of principal trading partners.
In Hong Kong, the city’s apparent exchange rate has been driven up by US dollar strength, compounded by an inflation rate that is higher than in its major trading partners.
By contrast, the real effective exchange rate has dropped by 7.8 percent in eurozone and 34.5 percent in Japan during the same period.
This variance has already been reflected in Hong Kong’s services and export sectors.
The city’s tourism and retail industries have suffered a lot. Mainland travelers have switched to Europe and Japan, and even Hong Kong residents have opt to spend their holidays in Japan or Europe.
As of the end of May, the city’s real effective exchange rate has risen 6 percent from last year’s average, according to data released by the International Monetary Fund in late June.
Thanks to the city’s effective adjustment system, prices of various goods, factors of production and assets are quite flexible. The real medium salary has already declined by 3 percent since the second half of last year.
However, these figures represent a painful process for both employees and businessmen. And the issue is already rippling from exports to other economic sectors. The city’s real salary index has dropped by 2.3 percent in the first quarter from a year before, according to government data.
Hong Kong has suffered seven years of difficulties after the Asian financial crisis as a result of excessively high real effective exchange rate. Falling salaries, housing prices, rents and surging unemployment rate have weighed heavily on economic growth.
Commercial properties like shops have already been affected by weakening retail growth. Shop rents are expected to drop by 20 to 30 percent.
And if the unemployment rate rises and salaries start to fall, housing prices will also be affected.
New housing projects are selling quite well at the moment as prospective buyers think there is a shortage of supply.
Nobel Prize-winning economist Robert Shiller wrote in column in the New York Times that the real estate market can build up a bubble easily as short-selling activities that we usually see in the financial market are limited in the property market.
Professional investors engage in short-selling to press down excessively high-priced financial products.
However, the property market is dominated by retail investors, and professional investors have limited participation in the market.
This article appeared in the Hong Kong Economic Journal on July 31.
Translation by Julie Zhu
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