• The Federal Reserve's (Fed) 50 basis point rate cut surprised the market on 18 April, viewing that the U.S. economy was still skewed toward further weakness. The increasing lay-off in service sectors, growing concerns over telecommunication and IT firm loans and fragile consumer and business confidence will pose threat to the U.S. economy in the second quarter.



• Given the Fed's latest remarks and the sudden rate cut, we do not rule out another 25-50 basis-point cut in May's FOMC meeting as market confidence remains shaky. Under the linked rate system, we expect Hong Kong interest rates will track U.S. counterparts.
  
  
• After expanding by 6.8% growth in the fourth quarter of last year, the Hong Kong economic growth in the first quarter is expected to moderate to about 1.5% mainly due to trade slowdown, sluggish consumption and higher base for comparison.
  
  
• Interest rate cuts will help offset part of the ill effect of economic restructuring on Hong Kong consumption through relieving the burden of interest payments on mortgage. In anticipation of further rate cuts in the near future and the moderate wage increases, retail consumption is expected to gather steam in the second half.
  
  
• We still expect the gradual rise in investment arising from the preparation of China's WTO entry (the entry schedule might be delayed to the end of this year or early next year on the tense Sino-U.S. relation) will be Hong Kong's main growth driving force.
  
  
• Given the weakening of U.S. and Japanese economy, the downturn in Hong Kong exports of goods and services will be more serious than we initially expect. Against this background, we lowered our economic growth forecast from 3.8% to 2.6% for Hong Kong in 2001 after 18 April U.S. rate cut.

The Federal Reserve surprised the market on 18 April by cutting both federal funds rate and discount rate by 50 basis points between its regular meetings on 15 May. The Fed in its release said that the economy was at risk of being "unacceptably weak" due to an uncertain business outlook, softening capital investment, an erosion in expected corporate profitability, effect of reductions in equity wealth on consumption and the risk of slower global growth. The U.S. economy was still skewed toward further weakness.

In light of recent positive industrial production and housing starts figures, tame consumer inflation environment and the upbeat tone of Fed officials on the economic outlook, the surprise rate cut rekindled hopes for more aggressive rate cuts ahead. The increasing lay-off in service sectors, growing concerns over telecommunication and IT firm loans and fragile consumer and business confidence will pose threat to the U.S. economy in the second quarter.

Given the Fed's latest remarks, a bleakening employment outlook, weakening business conditions (especially in the second quarter) and the sudden rate cut, we do not rule out another 25-50 basis point cut in May's FOMC meeting as market confidence remains shaky. In a word, we expect U.S. rates will be cut by a total of 2.25%-2.5% this year (the rate cut cycle likely to be ended in the first half). Under the linked rate system, we expect Hong Kong interest rates will be closely in line with U.S. counterparts.

Locally, the retail sales value in the first quarter eased slightly by 0.1% over a year ago on reducing consumer demand. Consumers have turned cautious on spending over the worry of a global economic slowdown, stock market slump and job security.

Nevertheless, with the transformation towards a knowledge-based economy and the preparation for China's entry into the WTO, an impressive growth of capital good imports retained for local use was reported in the first two months, suggesting that investment demand remained strong.

Externally, the sharp slowdown in the U.S. economy, economic moderation in EU and stagnating Japanese economy have weighed on Hong Kong export growth momentum while sluggish consumption demand has dampened the import growth. Both total exports and imports of goods started to slow sharply from double digits in the last quarter of 2000 to single figures. In the first quarter of 2001, the value of total exports of goods increased by 2.3% over a year earlier. Over the same period, the value of imports of goods increased by 3.6%. A visible trade deficit of HK$ 29.1 billion, equivalent to 7.7% of the value of imports of goods, was recorded.

After expanding by 6.8% growth in the fourth quarter of last year, the Hong Kong economic growth in the first quarter is expected to moderate to about 1.5% mainly due to trade slowdown, sluggish consumption and higher base for comparison.

On the price front, deflation has eased but still came into view as consumers' spending sentiment stayed cautious on the back of volatile equity market, shaky residential recovery, steady food prices and large price discount in retail businesses. 1999/2000-based Composite Consumer Price index was down by 1.9% in the first quarter of 2001 from 2.5% decline in the fourth quarter of 2000.

Over the labour market, the seasonally adjusted unemployment rate in January - March 2001, has further edged up to 4.6% from 4.4% in October - December 2000. The construction and real estate sectors showed a more distinct rise in unemployment. This was largely attributable to the slackening in the property sector. The ongoing economic restructuring has weighed on the labour market as concerns about the job mismatching. The slowdown in the global economies, particularly the U.S. economy, also added a negative impact on the trade-related job market.

Interest rate cuts will help offset part of the ill effect of economic restructuring on Hong Kong consumption through relieving the burden of interest payments on mortgage. In anticipation of further rate cuts in the near future and the moderate wage increases, retail consumption is expected to gather steam in the second half.

We still expect the gradual rise in investment arising from the preparation of China's WTO entry (the entry schedule might be delayed to the end of this year or early next year on the tense Sino-U.S. relation) will be Hong Kong's main growth driving force.

Given the weakening of U.S. and Japanese economy, the downturn in Hong Kong exports of goods and services will be more serious than we initially expect. Against this background, we lowered our economic growth forecast from 3.8% to 2.6% for Hong Kong in 2001 after 18 April U.S. rate cut.

Daniel Chan
Economic Research
Tel: 2218-8230