Inflation Returns to 2% Range...Complex Relationship Between Economy and Prices for Bank of Korea (Comprehensive)

Consumer Prices Rise 2.2% in January
Petroleum and Vegetable Price Surges Drive Inflation Back Above 2%

Consumer prices continued to rise, climbing back into the 2% range for the first time in five months. The surge in petroleum prices amid a high exchange rate environment and a significant increase in vegetable prices due to poor crop yields caused by abnormal weather conditions contributed to this rise. The simultaneous increase in international oil prices and exchange rates is acting as a factor that could further fuel inflation concerns, complicating the Bank of Korea's calculations regarding interest rate cuts.

According to the 'January Consumer Price Trends' released by Statistics Korea on the 5th, the consumer price index last month rose 2.2% compared to the same month a year earlier. This increase was the highest in six months since July last year (2.6%). Last year, consumer prices peaked in February and March (3.1%), then slowed to the 2% range from April to August, dropped to the 1% range in September (1.6%), and continued with a 1% range increase for five consecutive months. However, after falling to 1.3% in October, it rose for three consecutive months through November (1.5%), December (1.9%), and last month.

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The main driver behind the overall price increase was the rise in petroleum prices. Last month, petroleum prices rose 7.3%, a significant increase compared to the previous month (1.0%). With international oil prices rising at the end of last year and recent exchange rate volatility, petroleum prices surged considerably. The increase in petroleum prices raised the overall inflation rate by 0.27 percentage points. Petroleum products have a broad impact on various industrial products as well as overall energy prices.

Personal service prices, excluding dining out, also contributed to the overall inflation by increasing from 2.8% to 3.5%. Lee Doowon, Director of Economic Trend Statistics at Statistics Korea, explained, "At the beginning of the year, increased travel demand led to higher costs for overseas group tours and condo usage fees, and the rise in indemnity insurance premiums was another major factor." Processed food prices also rose 2.7%, the largest increase since January last year (3.2%), raising overall inflation by 0.23 percentage points.

Vegetable prices also surged significantly. Due to abnormal weather conditions such as prolonged heatwaves last year, some vegetable prices, including radish (79.5%), carrot (76.4%), and napa cabbage (66.8%), rose sharply compared to the same month the previous year. In particular, napa cabbage prices soared the most in two years and three months since October 2022 (72.5%) due to reduced shipments caused by adverse weather. However, some items saw price decreases, such as green onions (-32.0%), cucumbers (-11.6%), and tomatoes (-5.5%), and apples (-2.2%) showed a negative growth rate due to the base effect from the sharp price increases in January and February last year.

Core inflation, which excludes food and energy, rose 1.9% compared to a year earlier, showing a smaller increase than the previous month (2.2%). Hwang Kyung-im, Director of Price Policy at the Ministry of Economy and Finance, said, "We expect the inflation slowdown trend to continue into the second half of the year. Looking at core inflation, a level of around 1.9% to 2% is considered the inflation stabilization target, so it is difficult to conclude that inflation is very high at this point." The government stated that it will continue to use measures such as tariff quotas and releasing stockpiled agricultural products to stabilize prices, anticipating ongoing volatility in international oil prices and uncertainties from abnormal weather.

The return of inflation to the 2% range has deepened the Bank of Korea's dilemma. Until now, the market widely expected the Bank of Korea to cut the base interest rate by 0.25 percentage points at the Monetary Policy Committee meeting scheduled for the 25th. Since the economy was weakening but inflation remained stable, it was anticipated that the Bank of Korea would lower rates further to stimulate the economy. The economic growth rate shockingly recorded only 0.1% in the fourth quarter of last year, and the won-dollar exchange rate, which had surged to the 1,470 won range at the end of last year, stabilized somewhat to the 1,430 won range before the Lunar New Year holiday, creating conditions favorable for an interest rate cut.

The renewed rise in inflation poses an obstacle to the Bank of Korea's interest rate decision. The inflation outlook for this year is not optimistic. The trend of a persistently high exchange rate is pushing up import prices, and policies implemented by the new Donald Trump administration are acting as factors that could further drive inflation. Uncertainty in international oil price trends due to geopolitical instability is also increasing uncertainty. Kang Sung-jin, a professor of economics at Korea University, said, "Until now, with the economy deteriorating and inflation stable, a rate cut in February was taken for granted, but with inflation rebounding, the Bank of Korea's dilemma will deepen. Whether the inflation rise is a trend or temporary will be an important basis for the interest rate cut decision."