Norman Chan says inflationary pressure will increase demand for property in city

Hong Kong Monetary Authority (HKMA) Chief Executive Norman Chan warned Tuesday that the US and Europe may raise interest rates sooner-than-expected.

Chan, speaking at the Legislative Council's financial affairs panel, also said that inflationary pressure in the city would increase demand for property, but noted that the government had pledged to increase land supply in the coming years.

Chan said that the market expects central banks in the US and Europe to increase interest rates by 25 basis points (bps) in the first quarter of 2012. But he warned that borrowing costs could rise before then.

With US and European economic recovery taking place faster than expected, Chan said that the central banks there may shift from their ultra-loose monetary policies to a more neutral one based on inflation expectations.

"If the US starts to raise interest rates, I predict the magnitude of the interest rate hike will be 25 bps for the first time. To avoid creating greater shocks to the global financial market, I think the US may raise interest rates several times," Chan said. "This means the new interest rate hike cycle may contain several interest rate increases."

"When this happens, it will signal that the ultra-loose monetary environment has ended ... (but) if the US raises interest rate faster than expected, it will create a huge psychological gap between market expectations and actual interest rate hikes.

Chan stressed that the HKMA would closely monitor the situation and it may even reinforce the existing measures - or even introduce new ones - to clamp down on short-term speculative activity in the property market. However, he did not elaborate on what those new measures would be.

The HKMA in mid November tightened mortgage lending restrictions with a 50 percent down payment required on residential properties valued at HK$12 million or above. For properties valued between HK$8 million and HK$12 million, the down payment has been raised to 40 percent. In addition, the government also unveiled punitive stamp duties of up to 15 percent to curb property speculations. Chan told the panel that these measures had curbed speculation.

Chan noted that local banks are already retrenching their mortgage businesses as the net interest margins in this business segment have been compressed at a time when credit demand for other business lending remains robust.

Local reports said that Hang Seng Bank, one of the largest mortgage lenders in the city, has decided to exit the Hibor-based (Hong Kong interbank offered rate) mortgage business. The interest rate charged to mortgage lenders under the Hibor-based mortgage is much lower than the prime-based mortgage as the former interest rate is hovering around 0.15 percent plus interest spread while the latter stands at 5 percent plus spread.

Though the government and HKMA measures have been effective at reining in short term speculative activity, Chan admitted that local home prices started to rise again in January. In terms of new mortgage loans made and approved, as well as the application numbers under the Mortgage Insurance Program, the number of cases have been rising since January.

"The market is exhibiting a rising trend again at a time when inflation expectations are propelling more investors to see property investments as an inflation hedge," Chan said. He said the government may have to reinforce existing measures or perhaps even introduce new ones to safeguard the local banking system.

Chan also warned that if the US raises interest rates, it will provoke capital outflows from Hong Kong and investors will divert their capital to other high-interest rate regions for interest arbitrage.

Dow Jones contributes to this story.

China Daily

(HK Edition 03/02/2011 page2)