Hong Kong's economic recovery looks set to continue thanks to robust domestic demand, which should withstand the challenge of rising interest rates, surging oil prices and an uncertain trade outlook, analysts say.

Lehman Brothers has raised its 2005 growth forecast for the territory to 6 per cent from 5 per cent, while Bank of China (Hong Kong) sees the economy expanding 5 per cent, up from an earlier projection of 4.5 per cent.

"High consumption and investment confidence, a stable political atmosphere, positive wealth effects from both the stock and property markets, Disneyland, and mainland factors are all favourable elements that can offset (external) uncertainties," Bank of China said on upgrading its growth forecast.

Gross domestic product grew 1.5 per cent in the first quarter from the previous three months and was 6.0 per cent higher than a year earlier.

A look at recent Hong Kong economic data, however, reveals some worrying signs.

Two months of disappointing retail sales and a slump in residential property sales in July suggested a one-and-a-half-point jump in interest rates since May was hurting.

Shops are offering discounts of 50 per cent or more to get rid of end-of-season stock. And as consumers grapple with rising fuel costs, they were hit by another quarter-point rise in commercial bank interest rates this week.

Hong Kong tends to track US interest rate moves because of its currency peg to the US dollar and analysts forecast this week that lending rates could rise another three quarters of a point by the end of the year.

Property worries?

"A higher interest rate environment is not good for Hong Kong," said George Leung, chief economist at HSBC.

Property transactions a bellwether of consumer confidence fell 30 per cent in July from June. Rate increases in coming months will slow consumption and could drag down the economy, leading to a mere 4 per cent expansion in gross domestic product this year, Leung said.

But other economists are not so downbeat, predicting consumption and property purchases will rebound.

"A series of interest rate rises have hurt property transactions but they haven't depressed property prices," said Daniel Chan, senior investment strategist at DBS Bank.

"In the short term, property may consolidate but I don't see a crisis in the market. Wage prospects continue to improve and since the yuan's appreciation, Hong Kong asset prices are quite cheap."

Investment in Hong Kong has become cheaper for the Chinese mainland since Beijing revalued the yuan by 2.1 per cent last month.

While property investors are cautious, equity investors drove the stock market to its highest level in four-and-a-half years this week after a string of good company results.

Meanwhile, employment growth is solid and wages are rising for the first time in four years.

Goldman Sachs estimates that a 0.5 per cent rise in household income coupled with a 2.7 per cent increase in property prices offsets a one-point rise in interest rates.

The investment house expects retail sales to accelerate once Hong Kong Disneyland opens next month, ushering in a new wave of tourists, and forecasts 5.5 per cent economic growth for the territory in 2005, followed by 5.4 per cent in 2006.

Faster-than-expected growth in the United States, Hong Kong's second-biggest export market, could even stem a slowdown in trade.

But analysts agree that the property market needs monitoring. A rebound in property prices in the past two years has made consumers feel wealthier and ready to spend and that feeling could evaporate quickly if prices turn south, they say.

(HK Edition 08/13/2005 page3)