An employee at a currency exchange store counts Chinese one-hundred yuan banknotes in Hong Kong (Photographer: Xaume Olleros/Bloomberg)

Hong Kong's Economy Slows as Trade War, Rates Squeeze Looms

(Bloomberg) -- Hong Kong economic growth slowed in the second quarter, amid a deepening U.S.-China trade conflict and rising interest rates that are weighing on the outlook.

As a key trading hub for the flow of goods, services and capital between the world’s two biggest economies, Hong Kong is vulnerable to second-round effects as China and the U.S. impose tariffs on each other’s products.

While official forecasts show limited impact because the territory isn’t subject to U.S. tariffs on China due to the United States-Hong Kong Policy Act, the worry is that volumes will decline as production and shipping get moved elsewhere in Asia to avoid getting hit by the new duties.

“Over 50 percent of trade in Hong Kong is related to Mainland China,” said Iris Pang, greater China economist at ING Bank NV in Hong Kong. “When China is in a trade war, Hong Kong’s trade, logistic and ports would be negatively affected.”

Even before those effects kick in, growth softened from the fastest expansion since 2011 in the first quarter. Gross domestic product grew 3.5 percent in the second quarter from a year ago, according to the government, compared with a revised 4.6 percent in the first. Growth fell 0.2 percent quarter-on-quarter. The government maintained its full-year forecast between 3 and 4 percent.

Hong Kong's Economy Slows as Trade War, Rates Squeeze Looms

Growth Hit

“It remains to be seen how the escalation of trade conflicts between the U.S. and the mainland would affect the global economy and Hong Kong’s exports in the coming months,” Adolph Leung, deputy government economist, wrote in a press release. “The U.S. trade conflicts with the mainland, in particular, could weigh on global economic sentiment as well as trade and investment activities, possibly putting a damper on Hong Kong’s exports in the period ahead.”

If the tariffs on $200 billion of Chinese goods are implemented, nearly half of Chinese goods re-exported to the U.S. via Hong Kong could be affected, Edward Yau, Secretary for Commerce and Economic Development, said before the release. Still, all targeted items from both round of tariffs form only 3.5 percent of total 2017 exports.

The trade threat comes as the city’s port traffic is already in decline. Container throughput shrank throughout the first half of 2018 compared to 2017, amid fierce competition from Mainland China ports.

Indeed, Hong Kong’s port has lost its place as the fifth-largest container port to South Korea’s Busan this year. "We do not see Hong Kong regaining its top five spot and expect Busan to extend the lead over Hong Kong as the year progresses," said Rahul Kapoor, a Singapore-based transportation and logistics analyst with Bloomberg Intelligence.

Rates Squeeze

Hong Kong’s economy is feeling the squeeze from rising U.S. interest rates, with the Hong Kong dollar peg meaning the Chinese region imports U.S. monetary policy. HSBC Holdings Plc, BOC Hong Kong Holdings Ltd. and Standard Chartered Plc will raise mortgage rates starting Monday, following tightening of policy by the U.S. Federal Reserve.

Still, there’s plenty of strength in the economy too, with retail sales still strong, albeit slowing, and unemployment at its lowest in 20 years. So barring a slump in the territory’s sky-high home prices, it looks like a moderation, not a growth slump, lies ahead.

"Growth is likely to be moderate somewhat in the coming quarters due to higher interest rates and trade wars," said Eddie Cheung, Asia foreign-exchange strategist at Standard Chartered Plc in Hong Kong.

©2018 Bloomberg L.P.