[Why&Next] 'Inflation-Recession' Crossroads... Korean Economy Shaken by War Scenarios

Geopolitical Conflicts in the Middle East Spread Inflation Concerns
If International Oil Prices Rise Further, US Tightening Policy May Strengthen
However, Economic Recession Could Precede Inflation
Korean Economy May Also Waver Depending on Future War Developments

[Image source=Yonhap News]

As the war between Israel and the Palestinian armed faction Hamas destabilizes the international situation, the South Korean economy is also expected to be negatively affected. If the war spreads to the United States and Iran, the rise in international oil prices and inflation could intensify, increasing pressure for interest rate hikes both domestically and abroad. Conversely, if the war accelerates a global economic downturn, inflation and interest rate burdens may ease, but there are concerns about overall economic damage due to delays in export normalization.

According to major foreign media and financial and foreign exchange markets on the 10th, the conflict between Israel and Palestine has heightened geopolitical risks in the Middle East, spreading uncertainty across international commodity, financial, and foreign exchange markets. The first to be shaken was international oil prices. Although the warring parties are not major oil producers, Iran, a key oil-producing country, backs Palestinian Hamas, and the United States supports Israel. As a result, international oil prices have surged by about 4% immediately after the outbreak of the war.

Rising Inflation from the War Increases Pressure for Interest Rate Hikes in Korea and the U.S.

It is still difficult to predict the impact of this war on the South Korean economy. For now, with international oil prices rising sharply, there is a high possibility of negative effects on inflation. Recently, despite the surge in international oil prices due to production cuts by Saudi Arabia and Russia, the world's first and second largest oil exporters, Iran's increased production has acted as a factor to lower prices. However, this war seems to be increasing upward pressure on oil prices originating from Iran.

Especially since Saudi Arabia, the leading Arab Islamic country, could also get involved in the Middle East war, predicting the situation is even more difficult. Yoon Jae-sung, a researcher at Hana Securities, said, "This war involves not only political issues between Iran-Palestine and Saudi Arabia-Israel but also energy hegemony struggles surrounding Israel's natural gas development and the Eastern Mediterranean offshore gas pipeline," adding, "From an energy perspective, Middle East issues are not easily resolved."

If international oil prices soar and inflation rises, the U.S. Federal Reserve's (Fed) tightening monetary policy stance will strengthen, potentially further stimulating already unstable U.S. Treasury yields. If the Fed raises the benchmark interest rate by 0.25 percentage points within the year to curb inflation or if Treasury yields rise further, the South Korean economy could face capital outflows and a rise in the won-dollar exchange rate, and the Bank of Korea would have no choice but to consider additional interest rate hikes.

[Image source=Yonhap News]

Concerns More About Recession than Inflation... Won-Dollar Exchange Rate Also Falls

However, among experts, there is also analysis that the Middle East war will spur a global economic recession rather than inflation. Seo Sang-young, a researcher at Mirae Asset Securities, pointed out, "This situation could act as a new cause of inflation and expand Treasury yield increases, but depending on the circumstances, it could stimulate a recession, leading to increased demand for safe assets and a decline in Treasury yields, resulting in a different conclusion."

For now, since the Middle East war has begun, international oil prices are rising reflexively, but unless neighboring countries such as the U.S., Iran, and Saudi Arabia directly intervene, the rise in oil prices and inflation is expected to be limited. The Bank of Korea and the Ministry of Economy and Finance also cautioned against overinterpretation at a market situation review meeting the previous day, stating, "Although the volatility of international oil prices has increased due to this situation, considering that it is still the early stage, movements in the international financial markets remain limited."

According to the Seoul foreign exchange market on the same day, the won-dollar exchange rate started at 1,348.4 won, down 1.5 won from the previous closing price, and showed a relatively stable trend in the early session around the 1,340 won level. This is interpreted as reflecting greater expectations that inflation and the Fed's tightening stance will not worsen despite the Israel-Palestine war. Han Ji-young, a researcher at Kiwoom Securities, predicted, "Unless the situation escalates to direct involvement by Iran or Saudi Arabia, it will not cause significant changes in inflation or Fed policy outlook."

Increased Uncertainty for the Korean Economy... Swaying Depending on War Scenarios

However, if the global economic recession accelerates, the export-dependent South Korean economy could also suffer significant shocks. The government expects that from this month, inflation will stabilize and exports will return to an upward trend, marking the start of a full-fledged 'low in the first half, high in the second half' pattern, but uncertainties have increased due to U.S. tightening and the Middle East war. Although semiconductor exports, a key export item, have improved since last month, price rebounds remain limited, making it difficult to guarantee an improvement in the industry outlook.

In the short to medium term, the South Korean economy is expected to fluctuate depending on the course of the Israel-Palestine war, international oil prices, and the Fed's monetary policy stance. Park Sang-hyun, a researcher at Hi Investment & Securities, said, "Various conflict risks are increasingly likely to stimulate not only the economic cycle but also financial market instability," adding, "Political conflicts within the U.S. and unexpected Middle East instability originating from Israel are expected to further weaken global economic momentum."