HONG KONG: The city's annual inflation rate eased to a two-year low of 0.8 percent in February, as food prices rose less rapidly after the Lunar New Year holiday and the government waived public rents and fees.

Consumer prices rose at a slower pace than expected. Excluding government waivers, the annualized underlying inflation rate fell to 2.1 percent in February from 4.5 percent in January.

Taking the first two months of 2009 together to remove the distortion caused by the Lunar New Year, which falls at a different time every year, the headline inflation rate was 2 percent, down from 2.1 percent in December. The underlying inflation rate fell to 3.3 percent from 4.6 percent in December.Irina Fan, a senior economist at Hang Seng Bank, said slower rises in food prices drove the slowdown in inflation, which fell below what the market expected but enough to be surprising.

"Last year we had a high base effect with the Lunar New Year holiday in February when food prices were high on strong demand," Fan said. The Lunar New Year holiday was in January this year.

Food prices rose 3.1 percent in February and 11.2 percent in January but prices of electricity, gas and water dropped 43.1 percent, due to a government subsidy on electricity charges.

A government spokesman said the lower inflation rate reflected the flexibility of local costs and an adjustment of prices in response to the economic downturn.

He said the government expects inflationary pressures in Hong Kong to continue receding this year "as the local economy comes under the increasing impact of the deepening global recession."

Fan sees a distinct possibility of inflation dropping to zero but said actual deflation is unlikely.

"We believe that the rate will remain positive as the economic condition is likely to bottom out this year."

Citigroup analyst Cheng Cheng-mount said weak domestic demand will likely keep inflation under control and the headline CPI will likely turn negative in the coming months. The bank lowered its forecast for CPI growth this year to 1 percent from 1.5 percent.

(HK Edition 03/21/2009 page5)