25 April 2019
The beginning of interest rate increases in the US may spell the end to the long run-up in Hong Kong home prices. Photo: HKEJ
The beginning of interest rate increases in the US may spell the end to the long run-up in Hong Kong home prices. Photo: HKEJ

How deflation could drag down Hong Kong home prices

The US Federal Reserve is set to hike interest rates this year, remarks from Janet Yellen and other Fed officials suggest it’s getting closer to doing so.

The Fed funds rate shows there is now an 80 percent chance of a “lift-off” within this year, compared with 50 percent odds just last week.

If so, how will that affect the housing market in Hong Kong?

I believe the rate hike alone may have limited impact in increasing the burden of mortgage payments and hence weighing on property prices.

In fact, historical data shows housing prices rising considerably within the first six months after a first rate hike.

Hong Kong banks have increased mortgage rates eight times since 1985, and home prices have risen an average of 8.6 percent within the following six months each time.

Moderate easing of prices did occur after mortgage rates were raised in 1994 and 1999.

So, rate hikes have a very limited impact on home prices.

Therefore, the market may have overestimated the impact of higher interest rates on dampening housing demand.

However, the rate hike could have some influence on the housing market through deflationary pressure, a stronger US dollar and spiking US bond yields.

In Hong Kong, mortgage rates have remained at record low levels since 2011.

Mortgage rates do, in fact, move in an opposite direction from housing prices.

The real mortgage rate, after we subtract inflation, is even more closely linked in an inverse manner to home prices.

The nominal mortgage rate has had a correlation of -0.26 with home prices since 2002. 

The real mortgage rate has had a correlation of -0.54 with home prices.

That shows the real mortgage rate may have a bigger impact on home prices.

The real mortgage rate has rallied to -0.7 percent in recent months from a low of -4.2 percent as the annual rate of increase in the consumer price index plunged to 3.1 percent in June from 6.6 percent in September last year.

And inflation is set to decline further amid falling commodity prices if the Fed initiates “lift-off”.

It could even lead to deflation, which would drive up the real mortgage rate and reverse the excessively low levels of mortgage rates that have persisted since the financial crisis.

Since 2000, home prices have usually fallen when the real mortgage rate reaches normal levels.

If a US rate hike sparks a further decline in commodity prices and lower inflation, real mortgage rates would move up, which could create a substantial shock to Hong Kong’s property market.

The US dollar is expected to strengthen further as a result of the rate hike.

That could also weigh on Hong Kong’s home prices, an effect which usually occurs within 18 months.

The US dollar index has already posted a strong rally since mid-2014, and any further strength in the greenback would affect Hong Kong’s housing prices negatively.

The long-duration US treasury yield has spiked since the beginning of the year, and the yield on the 10-year treasury has surged from 1.6 percent to 2.5 percent.

That has somewhat reflected market expectations of a rate hike.

This article appeared in the Hong Kong Economic Journal on August 6.

Translation by Julie Zhu

[Chinese version中文版]

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Hong Kong Economic Journal chief economist and strategist

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