Beware the return of the killer zombie

Take care. Like a flesh-eating zombie, inflation may be about to rise from the dead to terrorise our city.

Admittedly, prices are rising at nowhere near the 15 per cent annual rate Hong Kong suffered in the early 1980s, nor even at the 10 per cent of the mid-1990s.

But there are danger signals. In March Hong Kong's consumer inflation rose to 2.4 per cent, higher than most forecasters expected and up significantly from last year's 2 per cent rate.

Even more worrying, Hong Kong is not the only place where prices are edging uncomfortably higher. On the mainland, inflation accelerated to 3.3 per cent last month from 2.7 per cent in February, exceeding Beijing's target for the year. Elsewhere around Asia, authorities are finding themselves forced to choose between appreciating currencies or rising prices at home.

Further afield, the British inflation rate rose to 3.1 per cent in March, more than a full percentage point above the official target. In the US price rises have been running well above the Federal Reserve's unofficial comfort zone for months now.

After years during which policy-makers worried more about deflation than price rises, the return of inflation signals a fundamental change in the economic environment.

Analysts offer differing explanations for the turnaround. Some blame the world's central banks for printing too much money. Others point the finger at China, saying demand generated by the mainland's rapid growth has pushed up energy and commodity prices and is finally feeding through to consumer inflation.

Whatever the cause, high inflation is bad news. It erodes the purchasing power of people's savings, while pushing up raw materials and wage costs for businesses. The cost of capital rises, discouraging investment.

Hong Kong is doubly vulnerable. As a small, trade-dependant economy, the territory is dangerously exposed to rising import costs. And if prices do shoot up, there is nothing we can do about it. Our currency board peg to the US dollar means local authorities can neither appreciate the Hong Kong dollar to take the sting out of higher import costs, nor raise interest rates to cool overheated domestic demand.

It is not yet clear that our inflation rate will climb substantially, but there are some worrying signs. Housing costs, which make up more than 25 per cent of the government's consumer shopping basket, are rising at an annual 4.5 per cent rate. With a shortage looming in the supply of rental flats, the housing component of inflation is only likely to rise further.

Hong Kong's buoyant domestic economy is threatening to compound the problem. With unemployment close to its lowest level in almost nine years, rising wages are adding to inflationary pressure, especially in the service sector.

Prices of many imports from the mainland are also climbing. After years in which China was a source of deflation, higher raw materials and energy costs and rising wages have finally caught up with the mainland's exporters. Clothing prices have risen 4.4 per cent over the past 12 months, food by 5.2 per cent.

And with the Hong Kong dollar tied to a falling US dollar, imports from the rest of the world are getting more expensive too.

The zombie may not be fully awake yet but it is showing scary signs of rising from the dead.