Aug. 20 (Bloomberg) -- Hong Kong probably ended a 68-month slump in prices last month as rising consumer demand allowed companies including Convenience Retail Asia Ltd. and Cafe de Coral Holdings Ltd. to start charging customers more.

The consumer price index probably rose 0.7 percent in July from a year earlier, the first increase since October 1998, according to the median forecast of 10 economists surveyed by Bloomberg News.

The return of inflation is helping to revive sales and profit growth for retailers, restaurants and hotel operators that cut prices in recent years as slowing economic growth and rising unemployment reduced spending. That may help create more jobs and sustain a recovery for Hong Kong's $159 billion economy, which expanded 6.8 percent in the first quarter, HSBC Holdings Plc Chairman John Bond said.

``That's good news for Hong Kong,'' Bond said in an interview in Hong Kong, where Europe's biggest bank employs 13,000 people. ``It shows that the bulk of the cost-adjustment process is behind us, and that hopefully we can get back to growth and higher consumer spending in Hong Kong.''

Convenience Retail Asia, which owns 192 Circle K convenience stores in Hong Kong, has cut discounts on promotional items such as Chinese iced tea and lobster-flavored chips by about half to 15 percent in the past year as consumers become more willing to spend, Chief Executive Officer Richard Yeung said,

``Customers developed a mindset that paying full price wasn't smart,'' said Yeung, who plans to add as many as 200 workers and open 18 new stores this year after first-half sales rose 15 percent, the fastest in three years. ``Now we're seeing less of that.''

Home Prices Rise

Consumer prices fell 0.1 percent in June, the smallest decline since deflation began in November 1998. The government will release the July consumer price report on Monday at 4:15 p.m. local time.

Fueling the return to price increases, average home prices climbed by a fifth in the first half of this year, according to CB Richard Ellis Ltd., the world's biggest commercial property broker. They slid two-thirds in the six years through mid-2003.

Unemployment was unchanged at 6.9 percent in July, the lowest since February 2002, and a surge in tourists from mainland China is helping to fill stores, restaurants and hotels.

Even so, many Hong Kong residents are still reluctant to spend after home values plummeted and companies shed workers in recent years, said Peter Wong, Standard Chartered Plc's chief executive officer for Hong Kong.

``Despite the fact that the economy is recovering, the psychology of people hasn't changed,'' Wong said. ``The propensity to spend isn't there yet.''

Competition From China

Increasing competition from China -- where wages and property prices are lower -- will cap price increases, said Andy Xie, Morgan Stanley's Hong Kong-based chief economist for Asia. Hong Kong is losing white-collar workers to the mainland as companies shift employees from Hong Kong to reduce labor costs, he said.

Competition from China ``requires a painful adjustment that involves further reduction in land prices and wages,'' Xie said in an Aug. 2 report. ``It is too early to declare victory over deflation in Hong Kong.''

Yet there are plenty of signs of a spending revival in the city. Retail sales, the clearest measure of consumer spending, climbed 14.5 percent in June from a year earlier.

Hong Kong-based Cafe de Coral, the world's biggest Chinese fast-food chain, raised prices as much as 6 percent in the past fiscal year and aims to raise them further ``because of strong consumer sentiment,'' Chairman Michael Chan said at a July briefing.

Lunchtime Crowd

During a recent lunch hour, a Cafe de Coral outlet in Hong Kong's Central business district was packed with office workers waiting in line to buy items such as roast chicken, baked pork chops and roast spare ribs.

``The change over the last 12 months has been remarkable,'' said Ken Courtis, Goldman Sachs Group Inc.'s Tokyo-based vice chairman for Asia. ``Deflation is gone, shops are full, restaurants are teeming. Hong Kong has a much different feel.''

Hong Kong's consumer prices began falling after the Asian currency crisis triggered a 1998 recession, with property prices leading the drop.

Declining real-estate values curbed spending by homeowners whose apartments were worth less than their mortgages. The number of homes in so-called negative equity rose to a record 106,000 -- 22 percent of borrowers -- in the second quarter of 2003, according to the Hong Kong Monetary Authority. It fell to 28,000, or 6 percent of borrowers, in June 2004.

Chinese Tourists

Last year's outbreak of severe acute respiratory syndrome, which killed 299 people in Hong Kong, hastened the price slide. Retail sales dropped to an 11-year low as consumers stayed away from restaurants and stores and tourist arrivals dropped.

An influx of tourists from the mainland has helped fuel the rebound since China's government allowed more citizens to travel to Hong Kong without joining tour groups in July 2003.

The city of 6.8 million people received a record 10 million visitors in the first half of 2004, more than half of them from the mainland, the Hong Kong Tourism Board said last month. The board predicts 20.5 million visitors this year, up 38 percent from 2003.

Hongkong & Shanghai Hotels Ltd., which owns the luxury Peninsula hotel overlooking Hong Kong's harbor, has benefited from rising tourist arrivals. First-half profit rose more than ninefold as sales jumped 31 percent. Room occupancy at the Peninsula almost doubled to 70 percent, and CEO Clement Kwok said he expects to raise rates by yearend.

Peninsula Discounts

The company's policy of not cutting pay meant that profit fell along with prices, Kwok said in an interview. Gross profit dropped to HK$522 million last year, the lowest in a decade, after peaking at HK$1.13 billion in 1996, according to Bloomberg data.

Kwok tried to sustain profit by cutting costs -- the company reduced its number of meat suppliers to consolidate purchasing, for example -- and wooing customers with discounts. The Peninsula introduced a weekend package for Hong Kong residents last year that included perks including a Rolls-Royce transfer and room- rate discounts of as much as 70 percent. The package is no longer available.

Convenience Retail's Yeung said persistent deflation meant consumers expected prices to keep falling, prompting them to hold off on spending unless heavy discounts were offered, Convenience Retail's Yeung said.

Circle K introduced weekly promotions in 2001 that cut prices of select items by about 30 percent, making it harder to boost profit margins, Yeung said in an interview.

`Catch-22'

``Without promotions, volumes would be very low,'' he said. ``It was a Catch-22 situation.'' Sales at stores open at least a year fell in both 2002 and 2003, according to Convenience Retail's Web site.

While Circle K still offers the weekly promotions, Yeung said discounts this year have been limited to around 15 percent.

The return of price increases may also spell the end of Convenience Retail's two-year salary freeze, Yeung said.

``If we get to the end of deflation, we'll have to review it,'' he said.

To contact the reporters for this story: Philip Lagerkranser in Hong Kong at lagerkranser@bloomberg.net

Last Updated: August 19, 2004 12:01 EDT