Middle East War's Prolonged Duration Sparks Concern Over Core Inflation in South Korea

Seoul is keenly observing the ripple effects of the Middle East conflict on its economy, particularly concerning inflation. The nation's price authorities are on high alert, focusing on core inflation trends as global oil prices remain volatile. This strategic focus stems from the understanding that while direct energy costs are excluded from core inflation, the indirect impacts—such as increased logistics and raw material expenses—pose a significant threat to price stability.

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As oil prices rise now, transportation costs for almost all manufactured goods and agricultural products, as well as raw materials like plastics, will increase, leading to price hikes with a time lag.

The current stability of core inflation, hovering around 2.2% year-on-year in March, offers a temporary reprieve. However, economists like Yang Junseok of Catholic University warn that the "transfer effect" of high oil prices is inevitable. As transportation costs rise and feed into the prices of manufactured goods and agricultural products, the pressure on core inflation will mount. This phenomenon, where initial price shocks gradually permeate the broader economy, is a well-understood risk, particularly given South Korea's reliance on imported energy and raw materials.

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Core inflation is quite downwardly rigid. It rises slowly, and once it rises, it doesn't come down easily.

History offers a cautionary tale. During the COVID-19 pandemic and subsequent geopolitical events, South Korea experienced how sustained increases in oil prices, even if initially excluded from core measures, eventually pushed core inflation into the 3-4% range for over a year. The "downward rigidity" of core inflation—its tendency to rise but not fall easily—means that any current price hikes could persist long after oil prices stabilize. This characteristic makes the monitoring of core inflation a critical task for policymakers aiming to maintain economic equilibrium.

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If the Middle East situation continues to escalate, it will eventually be reflected in rising core inflation with some time lag. In that case, policy alternatives to cope with stagflation, experienced in the 1970s, may be needed.

From a South Korean perspective, the situation is particularly sensitive. The government and the Bank of Korea are walking a tightrope, balancing the need to control inflation with the imperative to support economic growth. The potential for a return to stagflationary pressures, reminiscent of the 1970s oil shocks, looms large. As Professor Kang Byung-goo of Inha University suggests, proactive policy measures might be necessary if the Middle East crisis continues to escalate and translate into sustained domestic inflation. The upcoming confirmation hearing for the Bank of Korea governor nominee, Shin Hyun-song, highlighted this concern, with Shin stating that monetary policy tools would be employed if secondary effects on core inflation and inflation expectations materialize. This underscores the gravity with which Seoul views the current inflationary outlook.

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If the Middle East crisis continues to unfold and translates into core inflation and second-round effects, we must use monetary policy.