By: Our Correspondent

Hong Kong is experiencing yet another property bubble. But this one has arrived more by stealth, either because of a sudden burst of local euphoria or a surge of cash from the mainland.

Indeed the soaring prices are happening despite the efforts of the government to restrict non-resident buying by imposing additional transaction costs.  Nonetheless, residential prices in April were up 17 percent on a year ago.

Although a deceleration from the previous month, that is still a chunky figure given the year-ago base was already high by any standard – those of Hong Kong included.  It is now the most expensive property market in the world, and it is not for the faint of heart. The last time a major bubble popped was in 1997. Property prices fell for seven straight years, only bottoming out in 2004 after the Severe Acute Respiratory Syndrome – SARS – frightened buyers into the last gasp of downward movement.

Like elsewhere – London, Sydney etc. – the current price appreciation is partly driven by funk money with little place to go given rock bottom interest rates. But Hong Kong has two extra ingredients. The first is the familiar one of lack of supply thanks to years of government incompetence and surrender to the interests of the corporate clique which dominates land and development. The other, however, is a relatively high inflation rate – 3 percent –which has put borrowing costs into negative territory.

Nominal interest rates will of course follow those in the US. Whether Hong Kong buyers are prepared for that is not clear – just as it is not clear whether US stock and bond markets are either. The hidden shock may be that inflation itself will soon be a thing of the past unless things change very soon in both China and the west. Hong Kong’s inflation has become mostly home-grown and itself property related.

The US dollar-pegged currency is strong, inflation imported from the mainland is low and the renminbi is no long rising against the Hong Kong dollar. Meanwhile domestic demand is looking weak due to a decline in the number of mainland tourists and particularly of the big spenders in jewelry and high-end fashion shops. Yet the headline inflation rate is keeping wage growth in the 3 percent plus range.

Something has to give. One issue is whether the financial sector is either willing or able to support housing loan growth which has been running at around 12 percent, higher than overall loans and deposit growth. Another issue is whether deposit growth itself may stall or even go negative. Much depends on what happens in China. Mainland money can go into or out of Hong Kong dollars depending on un-predictable factors.

Supporting the market for now is a high unemployment rate and rising incomes. However, household debt levels are also high so a rise in real interest rates will hurt.

On the supply side, more new developments are coming on the market. Although they are still small relative to the total stock, Hong Kong prices are very susceptible to marginal supply and demand issues so even a small supply increase combined with a return to positive interest rates could send a shock.

The chances are that it will not happen in the immediate future. But month on month data may soon start flat-lining until the reckoning with a return to sustained positive interest rates hits home.