South Korean consumer inflation likely to hit 2 pct in 3Q17, says DBS Bank

According to the DBS Bank research note, the Bank of Korea (BoK) now expects inflation to converge with its 2 percent target by mid-2017, according to its latest economic outlook report released on 13th January. For the full year of 2017, the Bank of Korea forecasts inflation to average 1.8 percent, a notable rise compared to 1.0 percent in 2016.

We also think that headline CPI may hit 2 percent temporarily in the second or third quarter of 2017. Food prices have surged to 4-5 percent y/y over the past four months, due to a series of supply-side disruptions including the bad weather and bird flu. Barring a sharp, immediate reversal, food inflation will remain above the normal levels in the near term. Meanwhile, global crude oil prices have rebounded since last month. This should push up the costs of energy imports for Korea, which will be translated into higher public utilities and transportation fees in the CPI data, reported DBS Group Research.

The core CPI is also expected to remain at about 1.5 percent this year, barely changed from 1.6 percent in 2016. Note that the BOK has trimmed GDP growth forecast to 2.5 percent for 2017 at the January 13 meeting, down from 2.8 percent previously, citing the weakness in domestic demand especially private consumption. It has also estimated that potential GDP growth will be about 3 percent during the 2015-18 periods, they added.

This suggests that the output gap will remain negative through this year, wage growth will be subdued, and the demand-driven inflation will be muted. As such, a temporary rise in headline inflation to 2 percent doesn’t mean the Bank of Korea is going to raise rates to respond. Monetary policy is likely to remain accommodative this year.

In the financial markets, there is also a little expectation for rate hikes. The KTB yields have entered into a consolidation mode since December 2016 after being boosted sharply by higher global yields in November 2016. While the depreciation of the KRW has paused recently, it mainly reflected external factors including the dollar’s correction and the rebound in JPY, CNY and other major Asian currencies.