Wednesday, February 23, 2011

Inflation accelerates

Hong Kong's year on year inflation (as measured by the CPI) rose 3.6% in January according to figures released by the Census and Statistics Department yesterday.

This compares to 3.1% in December and consensus forecasts of 3.3%.

The increase was mainly driven by higher food prices and higher private sector rents. Given that food is (largely) a non-discretionary spending category and, for those not in taxpayer subsidised accommodation, rents are (largely) non-discretionary as well, there is relatively little that people can go to avoid the higher cost of living. While sweeteners can be expected in the forthcoming budget, the reality is that the Hong Kong government can't actually do anything meaningful to reduce the underlying inflation without changing the currency peg.

From this investor's perspective this is mixed news. As a net borrower (I still have a mortgage on my home and on most of my investment properties) whose cost of funding is below 1%, I am seeing the real value of my liabilities decline. As a holder of properties and equities, I can expect that, in the long term, that I will do better than an investor who was more heavily weighted towards more conservative investments such as bonds and cash - so long as I can live with the volatility. In the shorter term, I am seeing very noticeable increases in our grocery bills and certain other expenses. It is unclear what the impact will be on my income. However given that I have (I hope!) only this year and, possibly, next year to go before I retire the inflationary impact on my income is of less significance than the effect on my investments and my monthly spending.

I do not plan to make any changes to my investment strategy at this stage. If interest rates start rising I will consider making early repayments on some of the mortgages. If interest rates stay down below the level of inflation, I may come down off the fence and keep the mortgage on our home in retirement.

While rising demand and falling supplies have contributed to inflation (especially in food prices), the US Fed's frenetic running of the printing presses is also a meaningful contributor. It could almost be said that inflation is currently America's fastest growing export.

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