[BOJ Price Check] Inflation Hits 2%... Government Adding Fuel to the Fire

Bank of Korea 'Review of Inflation Targeting Operation Status'

BOK: "Possibility of Medium-Term Inflation"

Core Inflation Recovers from 0% Range to 1% Range Over Past Two Years

"Recovery Speed Faster Compared to Past Crises"

Second Supplementary Budget Up to 35 Trillion Won

Consumption Stimulus Effect May Fuel Inflation

Lee Ju-yeol: "Fiscal Policy and Monetary Policy Are Mutually Complementary"

[Asia Economy Reporters Kim Eun-byeol, Jang Se-hee] A notable point in the Bank of Korea's (BOK) recent inflation assessment is the suggestion that inflation may continue not only in the short term but also over the medium term of more than one year. BOK Governor Lee Ju-yeol mentioned the "possibility of medium-term inflation," citing a clear economic recovery and rapidly rising various price indicators. This contrasts with the government's stance, which places more weight on inflation stabilizing downward after the second half of this year. In particular, the BOK views the government's upcoming second supplementary budget bill of around 30 trillion won, to be announced next week, as potentially further fueling inflationary pressures.

"Inflation Fluctuating Around 2% in Second Half... Core Inflation Recovers Rapidly"

On the 24th, the BOK stated in its 'Price Stability Target Operation Status Review' that "with a rapid economic recovery, demand-side inflationary pressures are gradually increasing, so consumer price inflation is expected to fluctuate around 2% during the second half of the year." It forecasted that global prices, including raw materials, agricultural and livestock products, and crude oil, continue to rise, and the recovery in consumption demand due to expanded vaccination could further push prices higher. This implies that the annual inflation rate could exceed 2% depending on the pace of economic recovery.

Notably, the BOK is focusing on the fact that core inflation, which had remained in the 0% range over the past two years, is expected to sustain levels above 1%. Core inflation excludes items with volatile prices due to temporary external shocks and is a crucial indicator for central banks in determining monetary policy. This indicates that alongside supply factors, demand-side inflationary pressures are increasing as the economy recovers.

Breaking down the contribution to the consumer price inflation rate (year-on-year) by item for April and May, the contribution from services prices increased significantly alongside agricultural, livestock, fishery products, and petroleum products. In May, prices for personal services and dining out were in the high 1% range, close to the 2015?2019 average. Core inflation excluding food and energy recorded 1.2% last month, exceeding 1% for the second consecutive month, and core inflation excluding administered prices rose to the mid-to-high 1% range at 1.7%. The BOK assessed that the speed of core inflation recovery is faster compared to past crises.

Consumer price inflation rates in major countries are also expanding sharply. The U.S. consumer price inflation rate in May this year was 5.0%, the highest level since August 2008.

The concern is that the upward trends in prices of agricultural and livestock products, oil, and raw materials that have driven inflation so far may last longer than expected. Governor Lee Ju-yeol said at a briefing that "the rise in agricultural and livestock product prices is lasting longer than expected, and recently, international oil prices have exceeded the forecast made a month ago, surpassing $70 per barrel."

"Fiscal Support Increases Inflationary Pressure"

The government's continuous monetary expansion is also a factor stimulating inflation. The second supplementary budget size (up to 35 trillion won) amounts to 1.6% of South Korea's Gross Domestic Product (GDP), or 6.3% based on quarterly GDP. Implementing cashback, disaster relief funds, and additional issuance of local currency through the supplementary budget will stimulate consumption, inevitably pushing prices higher.

Recently, as the BOK signals normalization of interest rates in response to surging household debt and inflation, there are criticisms that the government's large-scale fiscal policy conflicts with this. Professor Kim Sang-bong of Hansung University’s Department of Economics said, "The government is injecting money to stimulate inflation, while the BOK continues to send tightening signals," adding, "Fiscal and monetary policies appear to be conflicting." He also noted, "Considering the current inflation level, the BOK's approach to prevent rapid inflation is appropriate."

If large-scale fiscal spending stimulates inflation, the effectiveness of future monetary policy may diminish. Professor Kim explained, "Fiscal policy directly affects consumption, rapidly raising prices, whereas financial policy works through banks and markets, causing a time lag," adding, "In terms of speed, fiscal effects act faster."

Governor Lee also urged mutual complementarity with fiscal expansion. At a press conference that day, he said, "It is desirable from the perspective of mutual complementarity between monetary and fiscal policies to focus fiscal support on enhancing productivity after COVID-19."

Professor Sung Tae-yoon of Yonsei University’s Department of Economics said, "It seems highly likely that the annual inflation rate will exceed 2.0% this year," adding, "Depending on how interest rate policy is handled in the second half of the year, inflation in the first half of next year could also be affected, and adjusting interest rates can help ease upward inflationary pressures."