HONGKONG Bank's move to cut its mortgage lending rates by 0.25 of a percentage point for some regular customers exposes the competitiveness of the territory's mortgage business during the downturn of the housing sector. It also strengthens Baring Securities assistant director Nichols Pang's belief that the mass housing sector will recover this year. 'I expect property prices to continue to consolidate in the third quarter of 1995 and to begin their uptrend in the fourth quarter of 1995 unless interest rates stay firm and confidence regarding the economic environment remains at low levels,' Mr Pang said. 'The projection is backed by Hongkong Bank's recent decision to cut its mortgage lending rates by 0.25 percentage point.' Hang Seng Bank, Bank of East Asia and First Pacific Bank have since offered similar cuts to the standard mortgage rate of 10.75 per cent. Mr Pang said more other banks were expected to follow suit, leading to a general interest rate reduction in the territory. 'That will be positive to the housing market, even if the impact is not to be reflected immediately,' he said. It is understood that interest rates play an important role in the movement of property prices. In Baring's latest report on the Hong Kong property market, Mr Pang said: 'In theory, for every 0.25 percentage point cut in mortgage rates, property prices should rise by approximately two per cent ceteris paribus.' He predicted that the Hong Kong prime rate would fall by 0.5 per cent in late 1995 and another 0.5 per cent next year. Based on his assumptions, home prices will be up between eight per cent and 10 per cent in 1996, because of the projected interest rates cut. Baring's expectation of an interest rate cut was backed by Kleinwort Benson Research, which expected to see a 10 per cent rise in flat prices next year because of rate cuts and other positive factors. Kleinwort Benson Research is part of the British merchant bank Kleinwort Benson Group, which was acquired recently by Germany's second largest commercial bank, Dresdner. In its latest report titled Hong Kong Property: After the Storm, Kleinwort Benson said there should be 0.25 per cent reduction in the prime rate in the next few months, making it slightly negative according to current inflation of approximately nine per cent. 'As further reduction is expected in 1996. By 1997, a negative real interest rate environment should re-emerge,' it said. A cut in interest rates is expected to enhance the spending capacity of prospective flat buyers. The capacity to spend is measured by a percentage ratio, the affordability ratio, and is calculated by dividing the average monthly mortgage payment on the borrowed amount plus interest, by the average monthly household income. Kleinwort Benson said assuming the Hong Kong prime rate declined to 8.75 per cent, the affordability ratio was expected to be about 54.9 per cent in the fourth quarter of this year, substantially better than the peak of 73 per cent in the third quarter of last year. Growth of household income and property prices also govern affordability. With a fall in property prices of 20-25 per cent since March 1994, coupled with continued rising household income, Kleinwort Benson said affordability had improved substantially and was expected to strengthen. In anticipation of strong demand and consistent supply of private mass residential flats, Kleinwort Benson and other economists believed that prices in Hong Kong's mass residential sector would rise next year and would accelerate in the following year. According to the government's Rating and Valuation Department's recent forecast, mass/medium residential supply in 1995 will be at 23,690 units, and next year they will be 26,070 units. This is substantially lower than the 32,170 flats recorded last year. However, demand is predicted to be largely increasing because of the accelerating growth in population in Hong Kong. As a result of an influx of immigrants, mainly from China, and a large number of emigrants returning to the territory, Hong Kong has registered a total population growth of 1.9 per cent this year, including natural growth. This is equivalent to a new private household need of 18,215 units, assuming a similar household size and similar proportion of private flats to total apartments. Taking into account possible new families created from shrinking household sizes, and new family formations from consistently high marriage rates, Kleinwort Benson predicted that the take-up of residential flats would rebound to 25,000 next year from the estimated 21,000 this year. The projected take-up rate in 1996 surpasses the supply estimated by the Government. Kleinwort Benson expects that the take-up rate will improve further to 27,000 units in 1997 and reach 29,000 in 1999. It predicted that the supply of mass residential flats would remain constant in the course of the next few years. Based on these assumptions, the mass residential sector is believed to see a good future for investors in the medium term. However, the market shows little signs of revitalisation in the short term. Despite an increase in the number of transactions in the primary market, sales activity in the secondary market has been virtually dormant while home prices have kept falling in the past few weeks. According to estate agents, home prices in some large housing estates such as Laguna City dropped by between five and six per cent last month. Analysts said though demand for private housing was strong, obviously the environment needed to be right for demand to be realised. Once interest rates had been cut substantially in the next 12 months, the environment would be ideal for demand to rise, they said. Some analysts said investors might want to consider whether they should take the opportunity to buy before others returned to the market.