[Q&A] Bank of Korea "Confident in Inflation Slowdown Trend↑... Need to Monitor Entry into Stabilization Phase"

February Revised Economic Outlook Briefing
Research Department "Structural Slowdown... Uncertainty Remains"

The Bank of Korea's Research Department emphasized on the 22nd that confidence in the trend of slowing inflation has increased compared to the past, but it stated that it is necessary to observe a bit longer before entering a price stabilization phase.

At the revised economic outlook briefing held at the Bank of Korea headquarters in Jung-gu, Seoul, the Research Department said, "Although the recovery in consumption will be slow, the inflation rate, centered on core inflation, will continue a gradual slowing trend," adding that the slowing trend is expected to pause temporarily due to rising agricultural product prices.

However, it emphasized that "as inflation approaches 2%, prices may not decline gently," suggesting that the 'last mile' (the phase toward the inflation target) may not be easy. Research Director Lee Ji-ho explained, "Globally, inflation rates tend to fall quickly when they decrease," adding, "As we get closer to the inflation stabilization target, factors such as oil prices and agricultural product prices influence the trend, making it difficult to proceed smoothly toward the target level."

[Image source=Yonhap News]

Below is a Q&A from the February economic outlook briefing with the Bank of Korea's Research Department.

- Unlike the November report last year which stated that 'inflation will slow down trend-wise but attention to international oil prices is needed for the time being,' this outlook mentions 'continued attention to oil price risks.' Is there a difference between 'for the time being' and 'continued'?

▲(Lee Ji-ho, Research Director) The fundamental expectation is that the inflationary trend will slow down. The process of stabilizing inflation is like walking on a bumpy unpaved road. Globally, inflation rates tend to fall quickly when they decrease. As we get closer to the inflation stabilization target, factors such as oil prices and agricultural product prices influence the trend, making it difficult to proceed smoothly toward the target level. Looking at the inflation trend on average, it indicates a downward stabilization trend.

- The outlook document mentioned 'the Federal Reserve will cut interest rates after the second half of the year.' Are you expecting a rate cut in the second half?

▲(Lee Ji-ho) The market expects the U.S. to cut rates around June. This is not to specify the timing of the rate cut but to explain that growth momentum is expected to improve during the second half of the year.

- Today’s Monetary Policy Committee’s main topic seems to be ‘domestic demand.’ The annual domestic demand growth forecast was lowered from 1.9% to 1.6%. What caused the 0.3 percentage point decrease? Also, why is it expected to improve in the second half?

▲(Kim Woong, Deputy Governor) We see that the impact of high interest rates and high inflation is affecting domestic demand. Additionally, the increase in household debt is constraining consumption among the core consumer age group of 30s to 40s. The reason for expecting improvement in the second half is that the burdens of high interest rates and high inflation are expected to ease somewhat.

▲(Lee Ji-ho) Looking at private consumption growth rates last year and this year, the recovery speed is not rapid. The ongoing high inflation and high interest rate environment seem to have affected consumption. If the phase changes, consumption is expected to recover as well.

- A recent report analyzed that 'the base effect of inflation should not be mistaken for entering a price stabilization phase.' So, do you consider the current slowing inflation trend as a base effect or as entering a price stabilization phase?

▲(Park Chang-hyun, Head of Price Trends Team) We need to observe a bit longer before concluding that we have entered a price stabilization phase. The base effect occurred after peaking in July 2022, followed by a year-long decline due to falling energy prices. After the base effect disappeared over a year, energy prices rose again, and agricultural product prices increased, causing a rebound. The base effect is a common global factor. Since then, from the second half of 2023, prices have been fluctuating or pausing. The base effect has largely disappeared.

- The monetary policy statement and economic outlook report mentioned that inflation uncertainty has slightly decreased. Has uncertainty reduced more slowly than before?

▲(Lee Ji-ho) I don’t think uncertainty has significantly decreased. In November, there was considerable anxiety about international oil prices, which has since lessened. However, inflation trends still face significant uncertainty from supply-side factors such as agricultural and fruit prices. Consumption is also sluggish, so whether these factors recover remains uncertain. Therefore, I do not believe inflation uncertainty has greatly diminished yet.

- The government announced inflation stabilization measures at today’s meeting. The Bank of Korea sees inflation slowing clearly. How might government management of inflation affect prices in the medium to long term?

▲(Lee Ji-ho) I think the government has roles to play, such as extending the fuel tax reduction for two months. The government’s role is understood as smoothing the overall inflation rate.

- The International Monetary Fund (IMF) forecasts this year’s economic growth at 2.3%, the Organisation for Economic Co-operation and Development (OECD) at 2.2%, and the government at 2.2%. Why do forecasts differ among institutions?

▲(Kim Woong) On average, the forecasts cluster around 2.1?2.2%. The overall numbers do not differ significantly. What is more important is that all agree that domestic demand weakness in consumption and construction investment is offset by strong exports, leading to growth. Although there are slight differences, they share the same perspective.

- Despite global oversupply issues in electric vehicles and secondary batteries, why is investment expected to increase?

▲(Yoon Yong-jun, Head of International Trade Team) There are oversupply issues in batteries and other products like petroleum products in China and other countries. Nevertheless, demand remains steady. The U.S. market for electric vehicles is still strong. From an industrial perspective, export items with high technological capabilities are expected to perform well.

- Has the speed of inflation decline accelerated, or has confidence in the slowing trend increased?

▲(Lee Ji-ho) Looking at recent movements, confidence in the slowing inflation trend has strengthened compared to the past. The speed of inflation decline can be fast initially due to the base effect. However, I emphasize that as inflation approaches 2%, prices may not decline gently.

- There is a large gap between private consumption growth in the first and second halves. You mentioned private consumption was weaker than expected. Was the approach conservative?

▲(Lee Ji-ho) Although consumption appears to increase sharply in the second half, the pace is not rapid. Consumption weakness is a common global factor. Central banks worldwide have maintained high interest rates to combat high inflation. Japan’s consumption is also weak, showing negative growth in the third and fourth quarters. Looking at the global economy and Korea, the U.S. and other countries differ. Korea’s real estate market has weakened, and although stock prices recently rebounded, they have risen relatively less compared to other markets. In the May outlook, I would like to say that inflation has stabilized more than initially expected, and consumption has increased.