Seoul: South Korea's monetary policy should focus on preventing core inflation from spreading broadly and remaining elevated as robust exports spill over into the broader economy and intensify demand-side inflationary pressures, a central bank report said Sunday.
According to Yonhap News Agency, the report published by the Bank of Korea (BOK) highlights that the recent strong performance in semiconductor exports is spilling over into domestic demand, potentially intensifying future demand-side inflationary pressures. The boom in artificial intelligence (AI) infrastructure has increased semiconductor prices and improved South Korea's terms of trade, with the country benefiting from robust semiconductor exports.
In the first quarter, South Korea's real gross domestic product (GDP) grew 3.8 percent from a year earlier, while real gross domestic income (GDI), which reflects changes in the terms of trade, expanded 13.2 percent. Typically, when oil prices rise, GDI grows more slowly than GDP due to the deteriorating terms of trade impacting South Korea's economy, heavily reliant on crude oil imports. However, the first quarter saw rising energy prices from ongoing military tensions in the Middle East being offset by strong semiconductor exports, allowing GDI to grow faster than GDP.
The report noted, "As the terms of trade improve due to rising export prices, GDI growth is significantly outpacing that of GDP, thereby expanding real purchasing power." This is likely to stimulate domestic demand in the future and increase upward pressure on prices. Past cases of demand-pull inflation, including during the post-COVID-19 pandemic period, saw private consumption increase as improved purchasing power boosted spending, subsequently fueling inflation while companies eased cost pressures by raising retail prices.
The report further explained that when the core inflation rate exceeded the mid-2 percent range, prices of other items across nearly all sectors rose in tandem, fueling higher core inflation. It indicated that during periods of high demand, a demand-side shock could add up to 0.6 percentage point to core inflation after six quarters.
It is essential to closely monitor not only the pace of the economic recovery but also the speed and intensity with which income growth resulting from improved terms of trade spills over into domestic consumption when assessing future inflation trends. The report emphasized that monetary policy must ensure that the rise in core inflation does not spread widely and become entrenched.
In response to these concerns, the BOK raised the benchmark interest rate at two consecutive meetings Thursday to 3 percent, describing the move as "unprecedented" but "preemptive" to curb mounting inflationary pressures as improved terms of trade boost domestic demand.