Domestic demand alone has contributed some 86% of real GDP growth in 1Q. The latest indicators show that domestic demand remains resilient and is likely to continue to drive overall expansion in the near term. Retail sales growth stayed solidly at double digits in April on the back of rising wages and good employment prospects. Unemployment rate hovered near 10-year low at 3.3% in April.

The outlook is more cautious, however, as the external environment remains patchy. The US is facing risk of stagflation - the double whammy of suffering both recession and faster inflation, as the credit crisis and surging oil prices start to impact its economy.

The labour market condition still looks encouraging. But it usually takes a time lag for cooling economic activities to see its impacts on the labour market. Signs of waning demand for workers are likely to become more obviously in the second half of the year to lift the unemployment rate up to reach an average of 3.8% for the full-year of 2008.

That said, the relatively tight labour market condition is likely to keep consumer spending running strong to provide some buffers to the slowing external sector. Overall, we still see real GDP growth in Hong Kong to decelerate in coming quarters to come to a growth of 5.0% for the full year of 2008.

But, soaring global food and energy prices have lifted our inflation expectation. While the headline CPI readings had been suppressed by government's property rate concession measures, the underlying inflation rate has been on an uptrend, surging from 2.0% in the beginning of 2007 to over 5% in recent months. We have therefore revised our full-year inflation forecast to 5.0% from 3.5%.

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