Hong Kong's economy has now recorded three years of falling prices, after the composite consumer price index slid by 1.2 per cent year on year for last month. Economists said the figure, the same as the September fall, was in line with expectations. 'It was in a trough of about [minus] 5 per cent in January last year and it recovered to about minus 0.9 per cent in July this year, but now it is sliding again,' said Nomura International senior economist Pu Yonghao. Hong Kong's three-year run of deflation began in November 1998. Economists said deflation was inevitable with a strong currency, given Hong Kong's dollar peg and the likelihood the US dollar would become stronger. It meant Hong Kong could only cut costs to remain competitive. Macquarie Services Hong Kong regional economist Li Lian Ong said persistent deflation meant retailers did not have the pricing power to pass higher costs on to consumers. 'It is hard for someone to put up their prices if there is no demand as it is,' Ms Ong said. 'There was a stage when the volume of sales went up as prices went down, now both are falling again with the deteriorating economic outlook.' HSBC chief economist George Leung Siu-kay said last month's 5.5 per cent decline in clothing and footwear prices was a 'symptom of the economy contracting'. Though prices in this sector had fallen by 20 to 30 per cent during the Asian financial crisis, this had happened because retailers discounted heavily to clear excess stock to cover their debts. 'This time [negative] 5.5 per cent is still very severe, because after the crisis retailers kept very good control of inventory and never let it stack up. Now they have to keep offering discounts because of sluggish demand,' Mr Leung said. 'If you are facing deflation, you are not going to spend, and if deflation continues, you are not going to enter into the property market.' Continuing deflation was more bad news for negative equity holders, he said. HSBC expected Hong Kong's third-quarter gross domestic product to contract by more than 2 per cent. 'I think Hong Kong people should not expect deflation will disappear soon, because this is just the start of the economic downturn,' Mr Leung said. Rental prices, which make up 30 per cent of the index, also declined by 1.7 per cent last month year on year, while the prices of durable goods dropped 7 per cent. However, consumers clearly drank and smoked their cares away last month, allowing retailers to increase the cost of tobacco and alcohol by 5.5 per cent compared with the previous October. Xen Gladstone, ING Barings head of Hong Kong research, said deflation was a 'necessary evil' in Hong Kong with its dollar peg. '[Deflation is] a bad idea because it undermines confidence,' Mr Gladstone said. 'If you have low interest rates and things are getting cheaper, why buy now?' The most obvious effect of deflation was cheaper fixed assets. Hong Kong property prices were already 60 to 65 per cent off their peak. One benefit of deflation however was that it forced companies to become more competitive. 'It sounds great, but in reality firms become more competitive by relocating their manufacturing bases to China. They cut costs by firing people - so unemployment goes up against a weakening global background - and they cut back on unnecessary expenses wherever possible.' Deflation had also come to Hong Kong in the form of traded goods, as people crossed the border to buy cheaper goods in Shenzhen; 44 million people crossed the Lo Wu border last year. 'We think [deflation] is going to last all of next year and ease going into 2003,' Mr Gladstone said. Mr Pu said deflation could reach a low point of negative 1.8 per cent but would not sink to minus 5 per cent or 6 per cent as it had after the Asian financial crisis. 'By the end of next year, we might see slight inflation.'