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Hong Kong is infamous for the most unaffordable housing in the world. According to the survey by Demographia, the price-to-income multiples (housing affordability multiples) in Hong Kong rises to 20.9X that far ahead of 2nd city – Vancouver (12.6X). In the previous article, we saw how real interest rates (monetary policy) affected the Hong Kong property market from 1992 to 2003. Let’s now consider real interest rates in Hong Kong over a more recent period – from 2008 to 2017. Investors may begin to see a pattern emerging. Again, the real interest rate played a key role in that!
The Financial Crisis
The Global Financial Crisis that began in 2008 has heavily shaped the current interest rate environment. In order to better understand recent trends, it is necessary to take a general view of the interest rate environment since 2008 and the corresponding property price performance. Consider the following table:
|Year||Change in Residential Property Price Level||Nominal Interest Rate||Inflation Rate||Real Interest Rate|
Sources: Rating and Valuation Department, Census and Statistics Department, Hong Kong Monetary Authority
In the aftermath of the Global Financial Crisis, central banks around the world, including the Federal Reserve in the United States, were implementing ultra-low nominal rate policies in order to salvage the global economy and financial system. A fixed exchange rate system is half demon half angel. On one hand, we enjoy a stable currency rate for international business. On the other hand, we compromise our monetary autonomy. With the HKD pegged to the USD, nominal rates in Hong Kong tended to track those in the U.S. In fact, nominal rates in Hong Kong were so low that even tepid inflation rates resulted in real interest rates entering negative territory. Market historians noticed that the years after 2008 looked very similar to the 1990s — negative real interest rates were driving up property prices.
What does our crystal ball suggest?
Starting in late 2015, the Fed determined that the U.S. economy had largely recovered from the Great Recession and it was time to return to a more traditional monetary policy. Since then, the Fed has raised the nominal interest rate 9 times (25 bps each time). Although the Hong Kong nominal rate has been slow to catch up with the U.S. rate, it will eventually move towards the U.S. rate due to the HKD-USD peg.
The other factor in determining the real interest rate––– the inflation rate––– has been trending down since 2014. Together with the rising nominal rate, we can expect a higher real interest rate in coming years.
The market appears to have reacted already to future increases in real interest rates. It’s probably no accident that property prices dropped in 2016, the year after the first Fed rate hike. The market was clearly expecting higher real interest rates to drag down property prices. In the future, as the nominal rate in Hong Kong further catches up with the U.S. rate, and assuming inflation remains modest, property prices in Hong Kong are likely to move towards a long-awaited correction.
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