By  on August 15, 2014

HONG KONG (Reuters) — Hong Kong's economy contracted in the June quarter as shoppers cut back on their spending, forcing the government to lower its growth target for the year.

The drop in consumption was driven by a decline in tourist spending largely aggravated by China's spreading anti-graft campaign. A drop in purchases of luxury items such as watches and jewelry, coupled with weak domestic spending, has led to five consecutive monthly declines in retail sales.

The $250 billion economy contracted 0.1 percent in the June quarter compared with a revised seasonally adjusted 0.3 percent expansion in the March quarter.

From a year earlier, the economy grew 1.8 percent in the June quarter, its slowest pace of expansion in nearly two years and compared with a revised 2.6 percent in the first quarter of 2014.

The government cut the full-year growth target to 2 to 3 percent from 3 to 4 percent at the start of the year. The economy expanded 2.9 percent in 2013.

Analysts said the slowdown was unlikely to reverse anytime soon with the government signalling only a slightly better second half thanks to an improving mainland economy.

"Domestic demand has taken a beating and despite the slight improvement in exports, it is going to be very hard to meet the revised growth estimates," said Kevin Lai, deputy head of economics at Daiwa Capital Markets in Hong Kong.

"I think a realistic target for full-year growth would be the 2 percent area," he added.

Consumption - the biggest contributor to Hong Kong's economy — is set to prove a drag with, "domestic demand likely to maintain only a rather slow pace of expansion in the second half of the year," the government said in a statement.

The Hong Kong retail sector relies heavily on mainland Chinese visitors who accounted for around one-third of Hong Kong's retail sales in 2013, Credit Suisse said in a recent report. Consumption followed by trade, and then investments, are the biggest drivers for economic growth.

Hong Kong's Retail Management Association has revised down the city's 2014 retail sales growth to 5 percent from 12 percent, with other analysts also cutting their estimates.

Six economists in a Reuters survey had forecast the second quarter would grow 2.4 percent from a year earlier. On a quarterly basis, three economists had forecasts ranging from a 0.7 percent contraction to 0.4 percent growth.

Following a weaker growth outlook, the government revised its full-year headline and underlying inflation forecasts.

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