• The economic landscape has changed significantly in recent months. Consumer price inflation crept up to 5.7% in May from to 5.4% in the previous month; and the rise in prices has become more broadly-based. Earlier this year, food-driven inflation was the centre of discussion and the shortage of food was deemed to be temporary.
  
  
• The food supply disruptions now seem not-so-temporary. What is worse, the high oil prices appear to be filtering through to other sectors, and the surging oil and commodities prices may yet reach their peaks in the international market. All these pose significant upside risk to our inflation forecast.
  
  
• On the trade front, Hong Kong's export performance has been stronger than expected as global demand remained firm despite the US's weakness. Hong Kong's exports gained 10.3% in May, after growing 14.5% in April, as shipments to major European and Asian markets were underpinned by the relative weakness of the Hong Kong dollar.
  
  
• In terms of domestic demand, however, signs of cooling demand are already evident. Retail sales volume grew a mere 5.5% in May, down from 11.5% in April. In addition, while the unemployment rate hovered at a 10-year low of 3.3% in May, total employment has been on a downtrend after hitting a peak of 3.55 million in January.
  
  
• The economic outlook is also uncertain. If oil prices rise further or stay at record levels, central banks in both emerging economies and industrialized countries may be forced to tighten monetary policy, posing downside risk to our growth forecast.

Retail Sales Growth Eased Sharply

Retail sales volume grew a mere 5.5% in May, down from 11.5% in April. In value terms, retail sales expanded 12.9%, driven mainly by rising prices.

Retail business in May was adversely affected by a number of factors. For a start, consumer sentiment in Hong Kong was dampened by the tragic Sichuan earthquake which resulted in huge losses in human lives. In addition, the number of Mainland visitors to Hong Kong dropped during the month as mainland China's "Golden Week Labour Holiday" was shortened to only one day this year, from the usual five days previously.

What is alarming is the widening gap between the value and volume growth, staying above seven percentage points for three consecutive months, indicating mounting inflationary pressure. For instance, the sales of food dropped 1.2% in real terms but climbed 14.3% in value terms. Fuel volume rose 12.6%, but the value was inflated to a 33.6% growth.

Looking ahead, the inflation pressure is becoming more challenging and the growth of the retail sales is likely to be driven by rising prices rather than volume.

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