The robust performance of Hong Kong's economy continued in 2005. The Gross Domestic Product (GDP) rose by an impressive 7.3 per cent in real terms, after a strong 8.6 per cent growth in 2004. After expanding by 6 per cent year on year in the first quarter of 2005, real GDP grew at 7.2 per cent in the second quarter and 8.2 per cent in the third. Economic growth remained well above trend at 7.5 per cent in the fourth quarter, thanks to very strong trade growth, and despite the dampening impact of higher interest rates. On a seasonally adjusted quarter-to-quarter comparison, real GDP expanded briskly in the first three quarters, by 1.6 per cent, 2.8 per cent and 2.2 per cent respectively in real terms before settling to 0.6 per cent growth in the fourth quarter.

The continued strong growth in external trade, both in goods and services, was an important factor in the economic recovery. Merchandise exports sustained double-digit growth during most of the year, supported by the strong performance of the global economy, the Mainland's vibrant trade flows and the increasing penetration of Mainland products in the world market. Of particular note was the double-digit growth in domestic exports in the second half of the year. The strong domestic export performance was attributable not only to a notable recovery in the clothing trade, but also to the remarkable growth in many non-clothing exports. As for invisible trade, inbound tourism continued to expand briskly in 2005 on top of the robust performance in 2004. The number of incoming visitors reached a record high of more than 23 million which underscored the further expansion of exports of travel-related services. Meanwhile, the Mainland's vibrant trade flows further boosted exports of trade-related services, notably offshore trade and, to a certain extent, exports of transport services. Also, exports of finance, business and other services grew in tandem with the upturn in business activities and an active financial market.

A more balanced pattern of growth was another distinct feature in the economic recovery, with both external demand and the domestic sector contributing to economic growth. Local consumer spending grew solidly during the year, indicating stronger consumer sentiment prompted by a rebound in employment and labour income, as well as the generally positive economic and employment prospects.

Overall investment improved over the course of 2005, particularly in machinery and equipment acquisition, supported by the continued brisk pace of business expansion and strengthened investor confidence. In contrast, building and construction activity remained slack all through the year mainly due to the fact that public housing programme had been scaled down earlier and also that there were relatively few large-scale infrastructure projects and private sector building projects in progress.

A third salient feature in the recovery was that it translated into a broad-based improvement in the labour market. Total employment expanded by a substantial 2.3 per cent in 2005. By the fourth quarter, the total number of people employed reached an all-time high of 3.43 million with more than 240 000 additional new jobs created since the trough in 2003, benefiting both higher and lower skilled workers across different sectors. Job vacancies likewise surged across major sectors. Along with a steadily improving labour demand, the seasonally adjusted unemployment rate fell successively, reaching a four-year low of 5.3 per cent in the fourth quarter of 2005. The number of long-term unemployed also fell noticeably and labour income rebounded moderately in money terms, reversing the decline in the previous years. While the current economic upswing created a number of higher-paid jobs, it also helped raise the average earnings of lower-income workers. The marked improvement in labour market conditions was boosted not only by the economic upturn but also a resilient and flexible workforce which, over the past decade, has become much better educated.

The property market as a whole continued to fare well along with the continuing economic upturn in the first half of 2005 but turned much quieter after interest rate increases accelerated in the second half. The adjustment was more apparent for residential property, with flat prices and transaction volume both easing off from their heights earlier in the year. Non-residential properties, however, were not affected to the same degree because of solid demand by investors. Meanwhile, the leasing market improved progressively because of a strengthening demand for rented properties. Rents moved up across the board with a sharper increase for office space during the course of 2005.

Consumer price inflation rose gradually over the course of 2005 in part because of the economic upturn but also because of the progressive effects of the rent rebound and higher oil prices. On a year-on-year basis, the Composite Consumer Price Index rose modestly by 0.4 per cent in the first quarter and 0.8 per cent in the second, and then accelerated to increases of 1.4 per cent in the third quarter and 1.8 per cent in the fourth.

Two factors kept consumer price inflation benign in spite of the strong economic growth — the comparatively moderate increases in unit rental cost and the stable labour cost per unit of output, the former being mitigated by improving business and the latter by the strong growth in labour productivity. The extent of imported inflation was also mild, especially in the second half of 2005 when the effects of an easing in oil prices and a stronger US dollar started to be felt.

As for the GDP deflator, the year-on-year decline, which began in the third quarter of 1998, was finally arrested in the third quarter of 2005, thanks to higher domestic prices and also the relative improvement in the terms of trade on account of a stronger US dollar. In the fourth quarter, the GDP deflator picked up slightly to a 0.7 per cent increase over a year earlier, though for 2005 as a whole there was still a marginal decline of 0.2 per cent.