The outlook for 2007 remains favourable, as the Hong Kong economy will continue to benefit from the Mainland’s strong economic performance given their close economic and financial ties. However, as global growth is expected to moderate in 2007, led by the slowdown in the US, a reduction in Hong Kong’s export growth is likely. The market consensus is for real GDP growth to decline to 5.3% in 2007 from 6.8% in 2006, partly due to a moderation in growth in the economies of Hong Kong’s main trading partners. Nevertheless, given a gradual appreciation of the renminbi and an expected weakening in the US dollar over the medium term, because of its sizable current account deficit and the halt in interest rate increases, the Hong Kong dollar effective exchange rate is likely to depreciate. This will offset part of the negative effect from weaker external demand. Domestic demand is expected to grow at a solid pace. Favourable labour market conditions and a steady rise in household income will continue to support consumer spending, while supportive monetary conditions will boost business investment.

Consumer price inflation is expected to pick up modestly in 2007, partly reflecting rising domestic demand and higher import prices against a general weakness in the US dollar and the continued appreciation of the renminbi. The market consensus is that CCPI inflation will increase to 2.3% in 2007 from 2.0% in 2006. But the risk of a substantial rise is small. The recent moderation in house price inflation, if sustained, will restrain growth in residential rents, which have a weighting of more than one-quarter in the CCPI basket. On the supply side, there has been little upward pressure on unit labour costs, while the inflation rate of retained imports moderated to 5.0% in 2006 from 8.4% in 2005.