The third quarter also did not get off to a good start. July retail sales volume growth was little changed at 6.6%, reaffirming the trend of softening real consumer spending, as rising prices eroded consumers' purchasing power. We see the growth of retail sales volume decelerate sharply from over 9% in the first half to about 3% in the second half to give an average growth of 6% for the full year of 2008. The situation is unlikely to improve in 2009, with retail sales easing further to a growth of 5.0%.

Consumer price inflation accelerated to an 11-year high of 6.3% in July, as surging global food and energy prices filtered through a wide range of consumer goods and services. In the next few months, the government's one-off measures of waiving public rentals and property rates and electricity subsidies will suppress the headline CPI reading, keeping the 2008 full year inflation rate at 5.0%. But the high underlying inflationary pressure would mean inflation will stay high at 5.0% in 2009, continuing to undercut consumers' purchasing power.

Consumers can expect little help from the labour market. As the economy slows, the unemployment rate is likely to rise to over 4% by year-end and may climb higher to an average of 4.5% in 2009.

While exports rebounded strongly in July, it may not imply a reversal of the weakening trend. With total exports facing strong headwinds from the heightened risk of a global slowdown, growth could decelerate to only 5% in the second half, from over 9% in the first half. Export growth is likely to slow to an average of 5.6% in 2009.

Against this backdrop, the Hong Kong economy looks set to lose further momentum. We have not only revised downward our real GDP growth forecast for 2008 to 4.3%, from an initial estimate of 5.0%, but expect further deceleration to only 3.3% for 2009, the slowest since 2003 when Hong Kong was plagued by the SARS crisis.

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