It takes time before an increased use of resources has an effect on price and pay increases! In the same way as it takes time to adjust inflation expectations downwards, there is inertia in shifting them upwards. This would mean that even if demand and production are higher than what is sustainable in the long-term, that this is not marked in price development before the use of resources has come under great strain. In the second place deregulations and increased competition can lead to consumer prices being dampened as a result of excess profits being forced down in previously sheltered industries. Initially, increased competition will perhaps primarily lead to redistribution of real incomes. In the somewhat longer term, productivity will also be improved. However, it is uncertain how quickly and to what extent potential growth will increase as a result of increased competition. If monetary policy assessments are based on an overoptimistic view of growth prospects and developments in consumer prices do not give any signals about this, this can lead to considerable imbalances being built up. Sooner or later, however, inflation will accelerate. When the scope for reduced profit margins as a result of deregulations and increased competition begins to be exhausted and demand pressure finally begins to be expressed in rising prices, there is a risk that price increases will be large and come quickly. Expectations of future growth prospects can then be abruptly interrupted. The consequences can be that demand drops if companies and households are then too highly indebted.
The current unusual circumstances are one of the main drivers for the prolonged boom in the local property sector. The risk of over-heating in the property sector to financial stability in Hong Kong is no smaller than that seen in 1997. We should note in particular that while mortgage rates were generally over 10% in 1997, after the burst of the property bubble, US interest rates have fallen, and mortgage rates in Hong Kong have spiralled down reaching about 2% in 2004. The situation we faced now is just the opposite. Mortgage rates are around 2%. And, even if the low interest rate environment were to remain until 2015 as anticipated by the US Federal Reserve, the US interest rates are bound to head back to more normal levels. Will mortgage borrowers in Hong Kong then be able to withstand the impact of interest rate hikes and property price falls? For example, under a 30-year mortgage, even though the borrower will be able to enjoy a low interest rate in the first two years, the repayment burden could become much heavier as a result of interest rate hikes in the years that follow. This could have serious consequences for the well-being of those families in the coming years. Therefore, I hope that the public will be cautious and should not underestimate the risks that rising interest rate could have on repayment ability, asset prices and the overall economy in Hong Kong. 2  BIS central bankers’ speeches