(Bloomberg) -- Hong Kong’s economy contracted last year for the third time since 2019 as slowing global demand, rising interest rates and a prolonged exit from isolating Covid curbs weighed heavily on the financial hub. 

Gross domestic product fell 4.2% in the October-to-December quarter from a year earlier, advanced figures from the Census and Statistics Department showed Wednesday. The drop was worse than economist estimates, though not as severe as the third quarter’s 4.6% decline.

For the entire year, the economy shrank 3.5%, more than estimates for a contraction of around 3% among economists and the government.

Weak trade was a contributor to the economy’s struggles last year, a government spokesman said in a statement, along with slackening domestic demand that was “dragged initially by the fifth wave of local epidemic and subsequently by tightened financial conditions.”

“Overall, the economy was very weak,” said Iris Pang, chief economist for Greater China at ING Groep NV. She cited office and shop vacancy rates that impacted employment and spending confidence, as well as the lack of visitors to the city.

Covid and high global inflation also impacted international trade volumes, she added.

Hong Kong’s economy was battered throughout 2022. The city struggled through a brutal wave of omicron infections toward the start of the year, forcing businesses to close and spurring officials to introduce a slew of social distancing measures that curbed activity. Hotel quarantine regulations for inbound travelers lasted for much of the year as well, deterring visitors and hurting activity. 

The weakening global economy and China’s Covid-fueled slowdown were other significant factors, contributing to Hong Kong’s suffering trade figures. Exports plunged in December by the most since the 1950s, with shipments to China alone plummeting 30% in the month from a year prior amid disruptions with the mainland and Covid outbreaks there. 

This year is looking better after the city and mainland China dropped Covid curbs. Hong Kong’s economy is projected to expand about 2.8%, according to the median estimate in a Bloomberg survey. China’s reopening was a factor behind the International Monetary Fund upgrading its global economic outlook for 2023. 

What Bloomberg Economics Says...

“Hong Kong’s economy struggled again in the last quarter of 2022, but we think the city is now set to rebound — and we’re raising our 2023 growth forecast to 3.2%, up from the 2.3% we projected in November. The main reason is China’s faster-than-expected border reopening after the abrupt end to its zero tolerance policy on Covid. We expect Hong Kong to reap big benefits in terms of tourism.”

— Eric Zhu, economist

Read the full report here.

Yet monetary policy tightening across the globe at the same time as demand for goods fades means 2023 will still cast a shadow. Hong Kong Financial Secretary Paul Chan last month urged caution, saying that there are still “uncertainties” to be aware of.

“The recovery isn’t fast and strong enough,” Chan said during a local television program. “Overall, some policies need to be adjusted and we can’t press ahead as we did before.” Chan will deliver his financial budget speech on Feb. 22.

“This year will be better” at least domestically, ING’s Pang said, though she added that “international trade will still be dull in 2023 as the global economy weakens further.”

A tourism rebound should also lift growth this year, according to Bloomberg Economics’ Zhu, who said visitors from mainland China typically accounted for about 80% of Hong Kong’s tourists before the pandemic.

The city’s monetary authority makes interest-rate decisions in line with the US Federal Reserve, given the local currency’s peg to the dollar. As the Fed embarked on an aggressive tightening cycle last year, that meant the Hong Kong Monetary Authority did too, following which the city’s biggest lenders have raised their own best lending rates. That has signaled higher borrowing costs for property owners during a rare downturn for the real estate market.

The Fed is widely expected to raise interest rates by 25 basis points on Wednesday, moderating its pace but also effectively ensuring a benchmark rate increase by the HKMA on Thursday.

The local dollar meanwhile, is inching back toward the weak end of its 7.75-7.85 per dollar trading band versus the greenback. A breach of the weak end would prompt the HKMA to start mopping liquidity to boost the currency — a move that would send borrowing costs higher, adding headwinds to the city’s economy.

--With assistance from Neha D'silva.

(Updates throughout, including commentary from Bloomberg Economics.)

©2023 Bloomberg L.P.