Hong Kong follows US Fed in cutting interest rate for the first time since 2008 as trade war weighs down on world economy

Hong Kong's monetary authority cut the city's base lending rate for the first time in more than a decade, reducing the cost of money in a slowing economy that had been squeezed by a year-long US-China trade war.

The city's de facto central bank reduced the base rate by 25 basis points to 2.5 per cent effective August 1, in lockstep with a widely expected cut of the same amount by the US Federal Reserve, the first reduction since the 2008 Global Financial Crisis.

"The US rate cut shows that the Federal Reserve has reversed its interest rate normalisation process that started in December 2015," the Hong Kong Monetary Authority's Chief Executive Norman Chan Tak-lam said at a media briefing in Hong Kong. "If the US continues to gradually reduce the interest rate in future, it will be positive for the global currency markets."

The rate cut is a much-needed spur to kick-start Hong Kong's economy, which contracted 0.3 per cent in the three months ended June from the first quarter, while the annual growth pace was stuck at 0.6 per cent from a year ago. The city's economy, a vital transshipment and re-export hub for the gigantic economic hinterland of mainland China with the rest of the world, had been squeezed by the year-long US-China trade war as the conflict kicked into high gear in early May.

The Hong Kong Monetary Authority's outgoing chief executive Norman Chan Tak-lam (right) with his successor Eddie Yue Wai-man (left), who will take over as the head of the city's de facto central bank from October 1, during an event on 25 July 2019. Photo: SCMP/Nora Tam alt=The Hong Kong Monetary Authority's outgoing chief executive Norman Chan Tak-lam (right) with his successor Eddie Yue Wai-man (left), who will take over as the head of the city's de facto central bank from October 1, during an event on 25 July 2019. Photo: SCMP/Nora Tam

"A lower interest rate will definitely be positive for the economy of Hong Kong, as well as the US, as it helps ease the burden for borrowers," said Sonny Hsu, vice-president and senior credit officer of Moody's Investors Service, adding that the financial markets are expecting three rate cuts in 2019 for a total of 75 basis points.

A slowing economy may translate into a pickup in unemployment rate from the current low of 2.8 per cent, Hong Kong''s Financial Secretary Paul Chan Mo-po said in his blog post this week, ahead of the HKMA's rate move. The job market has already weakened, particularly in the most-affected industries like import and export, wholesale and construction, he said.

Worse is to come, as the city had been shaken by unprecedented mass rallies ever since an estimated 1 million took to the streets on June 9 to oppose a controversial extradition bill. Even though the bill was declared 'dead" by Hong Kong's Chief Executive, rallies have persisted, and have turned increasingly violent.

Two continuous months of rallies have sapped retail sales and entertainment, putting homebuyers off big-ticket financial commitments like real estate. The effects of the unrest are likely to be felt in the third and fourth quarters of 2019, economists said.

"The current social unrest in Hong Kong means a lot of uncertainties in economic outlook," said Moody's Hsu. "Commercial banks in Hong Kong are likely to adopt a more cautious approach in their liquidity management and hence may not follow the HKMA to cut their best lending rate."

The Hong Kong Monetary Authority (HKMA) runs its monetary policy in sync with the US Fed to maintain the local currency's peg to the US dollar, in a currency board system since 1983.

The HKMA had followed the US Fed in raising the base lending rate nine times since December 2015, increasing the cost of money by 2.25 percentage points.

However, commercial banks may choose to keep their rates steady, with Hong Kong's lenders having increased their prime lending rate only once in September 2018, when they raised it by 12.5 basis points. The best lending rate, or prime rate, which is determined by commercial banks, is expected to be kept unchanged between 5.125 per cent and 5.375 per cent.

HSBC, one of the three currency-issuing banks in Hong Kong, was the first to announce that it is keeping its best lending rate unchanged at 5.125 per cent. The bank would cut its rate on US dollar savings by 10 basis points to 0.25 per cent, effective August 2.

"In spite of the protests in the past two months, we have not found evidence of capital outflow from Hong Kong," the HKMA's chief executive said. "US dollar deposits and Hong Kong dollar deposits in June remained stable. The Hong Kong dollar exchange rate to the US dollar has strengthened, reflecting the resilience of the peg and the financial system in Hong Kong."

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The rate cut will not have any impact on Hong Kong's residential property market, which is facing a critical juncture as homebuyers had been driven by political unrest in the city, said Knight Frank's executive director Thomas Lam. The sentiment was shared by the HKMA's chief executive.

"The key factors that affect Hong Kong's stock market and property over the next six months will be our social and economic situation, the US-China trade war and Britain's exit from the European Union," Lam said.

Still, the inventory of unsold homes rose to a decade-high of 10,000 units in June, while the price gauge of lived-in homes fell, as transactions stalled, while more property buyers chose to wait out the uncertainties.

"Although the rate cut will help improve the economy, investors should continue to be vigilant about their risk management as there are challenges ahead, including a possible worsening in the US-China trade war, a hard Brexit and other geopolitical tension," Chan said.

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2019 South China Morning Post Publishers Ltd. All rights reserved.

Copyright (c) 2019. South China Morning Post Publishers Ltd. All rights reserved.