[BOK Focus] Slow Inflation Deceleration... BOK Imminent to Revise Inflation Outlook

The Bank of Korea says "Slower slowdown than the US and Europe
But no big difference considering inflation peak and target deviation"
Unexpected variables like Middle East crisis
Inflation forecast revision inevitable
Delay in reaching 2% inflation target

"In the case of Korea, price stability has shown the best performance compared to any other advanced country." (May 22, 2023, Governor Lee Chang-yong)

Governor Lee Chang-yong of the Bank of Korea (BOK) praised in the National Assembly's Planning and Finance Committee meeting last May that Korea is approaching price stability at a relatively faster pace compared to other major advanced countries. However, a detailed analysis of the inflation slowdown rates in major countries revealed that Korea's inflation slowdown rate is not faster than that of the United States, Europe, and other major countries.

According to the BOK's report titled "Status and Evaluation of Disinflation (Slowdown in Price Increase) in Major Countries," published on the 30th, the slowdown rate of consumer prices after the peak in Korea, the U.S., and the Euro area was analyzed using three indicators: average monthly decline, half-life, and target convergence rate. The results showed that Korea's inflation slowdown rate was not faster than that of the U.S. and Europe.

Korea's consumer price inflation rate peaked at 6.3% in July last year and recorded 3.7% in September this year. The average monthly decline was 0.19 percentage points, which was smaller than Europe's (-0.57 p.p.) and the U.S.'s (-0.36 p.p.). During the same period, the progress rate toward the inflation target (2%)?the target convergence rate?was 60.5% for Korea, lower than the U.S. (76.1%) and the Euro area (73.3%). Considering that the consumer price peaks in the U.S. and Europe were much higher at 9.1% and 10.6%, respectively, and that as of last September, the U.S. and Europe recorded consumer prices of 3.7% and 4.3%, respectively, the inflation slowdown in major advanced countries was faster than in Korea.

In particular, while the U.S. and European regions continue to experience high service price inflation rates, which are heavily influenced by demand and wage pressures, Korea shows a relatively slower slowdown in core goods prices. This is analyzed as a result of Korea's high dependence on imported raw materials and the rising exchange rate, which continue to exert cost-push inflationary pressures.

Choi Chang-ho, Director of the BOK's Research Department, explained, "Although the average monthly price decline is smaller than that of the U.S. and Europe, this is due to Korea's lower peak inflation level. When considering the decline together with the peak and the deviation from the inflation target, Korea's inflation slowdown rate is not significantly different from that of the U.S. and the Euro area."

The problem is that unexpected variables such as the war between Israel and the Palestinian armed group Hamas are likely to slow Korea's inflation slowdown rate more than initially expected. The World Bank, in its "Commodity Market Outlook" released on the 30th, stated that if this war develops into the worst-case scenario, a situation similar to the first oil shock could occur, reducing global oil supply by 6 to 8 million barrels per day and causing oil prices to surge to $140?157 per barrel. If international oil prices and agricultural product prices remain high as recently, the resumption of the slowdown in consumer price inflation is likely to be delayed. Accordingly, attention is focused on how much the BOK will revise upward this year's and next year's inflation forecasts in its upcoming revised economic outlook next month.

Major forecasting institutions, including global investment banks (IBs), predict that the U.S. will reach the 2% inflation target by 2026, the Euro area by the second half of 2025, and Korea by the first half of 2025. Although Governor Lee previously mentioned that "the inflation rate will converge to around 2% by the end of next year," the consensus is that the timing of reaching the inflation target may be delayed compared to initial expectations. Recently, the market has also been raising its inflation expectations one after another.

Jin-wook Kim, an economist at Citibank, said, "Due to higher-than-expected food prices, the inflation rate in October is expected to rise to 3.8% year-on-year," adding, "We have revised upward this year's and next year's inflation rates by 0.1 percentage points each to 3.7% and 2.5%, respectively." Seok-gil Park, an economist at JP Morgan, forecasted, "Due to a sharp rise in vegetable prices, the inflation rate in October is expected to rise back to the 4% range at 4.0%," and predicted, "Reflecting the surge in food prices and oil price forecasts, the BOK will raise its inflation forecast in the revised economic outlook next month." JP Morgan's inflation forecasts for this year and next year are 3.7% and 2.5%, respectively. In August, the BOK forecasted an annual consumer price inflation rate of 3.5% for this year and 2.4% for next year.

A BOK official said, "If the conflict in the Middle East expands further amid the ongoing Ukraine war, prices of oil and other raw materials could surge sharply, exerting upward pressure on inflation, making it inevitable to revise inflation forecasts upward. However, since there is still about a month until the November forecast, we will decide the extent of the upward revision while monitoring the Middle East conflict and oil price trends."