Raw CPI numbers hit nerve as HK looks set to play inflation catch-up

PUBLISHED : Tuesday, 27 July, 2004, 12:00am
UPDATED : Tuesday, 27 July, 2004, 12:00am

PARDON ME FOR harping away on the inflation theme again but I think it is an important one as we are on the point of having to change our way of thinking about consumer prices after a six-year period of deflation.

The official line on the consumer price index report for June is that we are still just barely in deflation with prices down 0.01 per cent from June last year. That figure may be correct as far as it goes but it does not go very far. The fact is that consumer prices started to turn up in August last year and, although they are not yet rising quickly, they are set to do so soon.

Year-on-year change is just one way of measuring inflation. There are others just as good and the best of them is probably the straight raw numbers of the composite CPI.

I have shown them in the first chart from the beginning of last year and my point about August last year should be quickly apparent from the red line for the overall CPI. That month marked the final bottom of a pronounced decline occasioned by the Sars epidemic. When we start comparing present consumer prices against that bottom in two months time we will certainly see positive numbers in the CPI report.

But there is more to take into consideration here. The two components of the CPI still dragging prices down are housing and durable goods.

I have made my point about housing before but let me do it again. We measure only housing rents in this component, not prices, and we measure them not on the basis of latest rents, which are now starting to rise, but on the basis of what people are actually paying on a standard two-year lease.

Thus this housing component is not only a poor reflection of the costs but also one that is always well behind the times. It still indicates a more than 6 per cent year-on-year decline in housing prices. No way.

In durable goods, prices have been falling for years across the entire world because of production and retail efficiencies. You might call this the Wal-Mart effect. Things are changing now, however, because of rising commodity prices, which are in turn largely the result of a sagging US dollar. Take note that our currency is pegged to that dollar and our durable goods CPI will take the full hit of those rising commodity prices.

So let us play with the numbers by taking housing and durable goods out to show what the future may hold for us. You now get the blue line, indicating that the CPI bottomed in June last year and as of last month already showed a 2.4 per cent year-on-year increase.

I could make it worse yet. Take the trend in spot residential rents as a substitute for the CPI's housing component and take the US manufacturing price index for durable goods as a substitute for what we have in our CPI and we would now already be at 4.4 per cent year-on-year inflation. I grant you this is stretching things but it tells you what could be coming our way in these two components.

And now a third way of looking at things. Our CPI tells us consumer prices in Hong Kong have fallen by about 13.5 per cent since their peak in May 1998. This is not a huge figure when we think of all the laments we have sung about deflation since that time but it may still understate what has happened.

What it ignores is that consumer prices have not remained constant elsewhere over that time. How does our CPI stand when compared with price trends abroad? The second chart gives you an indication of this.

The red line here shows the Hong Kong CPI, steadily down from May 1998, which I have given an index value of 100. The blue, green and brown lines show you the respective equivalents for Asia outside of Japan, the US and the European Union.

Take only that weighted average of the rest of Asia outside of Japan and you get an index value for June this year of 118.5. Now compare that with our standing of 84.5 and the result tells you that Hong Kong consumer prices have lagged the rest of Asia by 28.7 over the past six years, although the Hong Kong dollar's exchange rate against the currencies of those countries is about where it was six years ago. We may be playing catch-up here soon.