Monetary Authority Chief Executive Joseph Yam says although a negative real interest-rate environment is more potent in the risks it presents to economic and financial stability, Hong Kong's banking system has a good track record and should be able to ride out this period.

In his weekly Viewpoint column published on the authority's website today, Mr Yam said following recent cuts in US interest rates negative real interest rates have become an issue of considerable interest in Hong Kong.

"Generally speaking, negative real interest rates are an abnormal phenomenon that have implications for economic and financial stability."

Consumption encouraged

Noting deposit interest rates are lower than the rate of consumer price inflation, Mr Yam said one possible effect of this is to encourage consumption and discourage saving - leading to even higher inflation, at least in the non-traded-goods sector.

"This may affect economic and financial stability. But consumers should bear in mind the possibility of disappointment on the economic front being transmitted from our major trading partners later in the year and not get carried away on a spending spree."

He said the negative real interest rate also means mortgage interest rates are lower than the rate of increase in residential property prices.

"When the mortgage rate is at 2.75% and the expected rate of increase in residential property prices is much higher, buying your own home or investing in property seems quite attractive."

Property prices volatile

"But perhaps we should all pause for a moment and look back at history. In the past 30 years, real mortgage interest rates, defined as the difference between the mortgage interest rate and expected rate of property price appreciation in the following year, have been very volatile - in some periods (for example, between late 1997 and 2002) real mortgage interest rates were highly positive," he said.

"This mainly reflects the fact property prices in Hong Kong have been very volatile. This volatility probably has something to do with the limited supply of land and the rather long time lag - perhaps because of the time needed for the construction of high-rise buildings - with which the supply of property catches up with demand. It is the imbalance between supply and demand, rather than negative interest rates, that drives property prices in the medium term."

Mr Yam said there is no doubt, however, a negative-real-interest-rate environment is more potent in the risks it presents to economic and financial stability.