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Negative interest rates It is important to be clear about what real negative interest rates are and what causes them. Following the recent cuts in US interest rates aimed at stopping the economy from slipping into recession, negative real interest rates have become an issue of considerable interest in Hong Kong. Generally speaking, negative real interest rates are an abnormal phenomenon that has implications for economic and financial stability. Given a choice, we'd prefer not to have negative interest rates. But we don't have a choice. Hong Kong is a highly externally oriented economy. As readers are aware, the two largest trading partners of Hong Kong are the Mainland and the US. We cannot realistically expect the trend of inflation in Hong Kong to be much different from those of our trading partners. Inflation rates in these markets have been rising recently, to almost 7% on the Mainland and 4% in the US. While these are headline numbers and the corresponding core inflation rates are lower, they go some way to explaining why the inflation rate in Hong Kong has been edging up recently. Because of the very different impacts of the sub-prime crisis on different jurisdictions, the monetary policy in the US, which we import through the Linked Exchange Rate system, is currently not entirely appropriate for Hong Kong. With higher inflation and with our economy continuing to perform strongly, we would have liked to see positive rather than negative real interest rates. But it is important for us not to lose sight of the reasons underlying the current phenomenon. Interest rates in the US were cut for a very clear reason ¡V to reduce the likelihood of the economy going into recession. With our second largest trading partner at risk of a recession, Hong Kong will be affected sooner or later, probably through the financial channels first, and later through the economic and trade channels. Whatever you think about the currently popular decoupling theory, the economy of Hong Kong, being so externally oriented, can never be decoupled from those of our major trading partners. And I am sure readers have noticed the desire of the Mainland authorities to cool the economy there, which also presents some risks to the outlook for Hong Kong¡¦s economy. Hopefully, the prospect of some slowing in our economic growth rate will have a dampening effect on domestic inflation and limit the extent to which domestic interest rates become negative in real terms. We should also be clear about exactly what negative real interest rates mean. There are two dimensions to this. The first is that deposit interest rates are lower than the rate of consumer price inflation. One possible effect of this is to encourage consumption and discourage saving, leading to even higher inflation, at least in the non-traded-goods sector. This may affect economic and financial stability. But as I said earlier, consumers should bear in mind the possibility of disappointment on the economic front being transmitted from our major trading partners later in the year and not get carried away on a spending spree. The second dimension is the phenomenon of mortgage interest rates being lower than the rate of increase in residential property prices. Indeed, when the mortgage rate is at 2.75% and the expected rate of increase in residential property prices is much higher, buying your own home or investing in property seems quite attractive. But perhaps we should all pause for a moment and look back at history. In the past 30 years, real mortgage interest rates, defined as the difference between the mortgage interest rate and expected rate of property price appreciation in the following year, have been very volatile ¡V in some periods (for example, between late 1997 and 2002) real mortgage interest rates were highly positive. This mainly reflects the fact that property prices in Hong Kong have been very volatile. This volatility probably has something to do with the limited supply of land and the rather long time lag (perhaps because of the time needed for the construction of high-rise buildings) with which the supply of property catches up with demand. It is the imbalance between supply and demand, rather than negative interest rates, that drives property prices in the medium term. There is no doubt, however, that a negative-real-interest-rate environment is more potent in the risks it presents to economic and financial stability. As the banking regulator the HKMA must take great care to ensure our banking system has the proper risk management systems to cope. Our banking system has a good track record and I am confident that we will be able to ride out this period of negative real interest rates as we did earlier ones. Joseph Yam ¡@ Click here for previous articles in this column. ¡@ |
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