The impact of the strong dollar-driven rise in the won-dollar exchange rate on inflation has been found to be limited. In the fourth quarter of last year, the main factor behind the exchange rate increase was the strong dollar due to U.S. trade uncertainties and other reasons. As a result, even if the exchange rate rises to 1,500 won, the likelihood of the consumer price inflation rate significantly exceeding 2% is considered low.
On the 29th, the Korea Development Institute (KDI) released a report titled "The Impact of Recent Exchange Rate Fluctuations on Prices," which included these findings. KDI's analysis of the recent exchange rate fluctuations on consumer prices found that the impact of exchange rate increases due to the strong dollar was relatively greater than factors related to domestic political or social changes.
In the fourth quarter of last year, consumer prices rose by 0.31 percentage points year-on-year due to won-dollar fluctuations, with 0.2 percentage points attributable to the strong U.S. dollar. Domestic factors contributed only 0.1 percentage points. Notably, from the first quarter of this year, the influence of the strong dollar has expanded significantly. Kim Junhyung, a research fellow at KDI, explained, "This is because the impact of the dollar has further expanded while domestic factors have remained constant."
KDI emphasized that the effects on prices differ between exchange rate increases caused by the strong dollar and those resulting from a combination of domestic factors leading to a depreciation of the won. Exchange rate increases due to strong dollar factors tend to accelerate inflation in the short term, but over time, the impact on import prices gradually diminishes.
Kim stated, "Because most imports are settled in dollars, the price in won rises immediately in the short term, but as prices are adjusted, the won-based prices inevitably come down over time." In contrast, exchange rate changes due to domestic factors broadly affect the value of the won relative to trading partner currencies, leading to a more widespread impact on import prices. Over time, the effect of exchange rate increases can become relatively larger.
KDI projected that the recent high exchange rate, as long as the won-dollar rate does not surge sharply in the future, is unlikely to push the inflation rate above the 2% price stability target. If the won-dollar exchange rate rises to 1,500 won, consumer prices are expected to increase by up to 0.24 percentage points. Conversely, if the rate falls to 1,400 won, consumer prices could decrease by up to 0.44 percentage points compared to the first quarter.
KDI stated, "Given that demand pressure remains low, even if the rate rises to 1,500 won, the likelihood of the consumer price inflation rate significantly exceeding 2% is not high." The institute also advised, "Since exchange rate increases due to the strong dollar may have only a short-term impact, monetary policy should take this into account."
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