ⓒ Getty Images Bank

Prices in Korea are increasingly under upward pressure. According to Statistics Korea, consumer prices in April rose 2.3 percent year-on-year, marking the sharpest increase in three years and eight months. The figure exceeds the Bank of Korea’s inflation target of 2 percent. Inflation not only places a burden on economic players but could also lead to an interest rate hike. 

Here is Lee In-chul, director of the Real Good Economic Institute, to examine the recent uptrend in prices and the possibility of an interest rate increase. 

The rapid increase in consumer prices in April was driven by rising prices of farm and oil products. Prices of agricultural and fisheries products increased over 13 percent last month, posting double-digit growth for four consecutive months. Housing prices also showed the sharpest growth since December 2017. The surging prices are feared to deteriorate the livelihoods of low-income citizens, who have yet to feel the warmth of economic recovery. While some experts raise the possibility of looming inflation, the government claims that it is only a temporary phenomenon and prices will remain stable overall this year. 

Externally, international oil prices have jumped. Internally, pent-up consumption amid the prolonged COVID-19 pandemic is released. 

Therefore, a rise in both supply and demand has driven up prices. The rise in prices in agricultural and fisheries products is attributed partly to flood damage and unusual weather last year, as well as the spread of bird flu. 

The drastic rise in grocery, oil and housing prices is making the lives of the already struggling low-income earners even more difficult. On a more disturbing note, the upward trend of prices will continue for a while, due to the base effect from last year and international oil prices that will likely to show an uptrend movement. 

Korea is not the only country to see this phenomenon. U.S. consumer prices rose 2.6 percent in March, compared to a year ago. Against the backdrop of the rapid rise in prices, a U.S. government official has hinted at the possibility of an interest rate hike. 

U.S. Treasury Secretary Janet Yellen said last week that interest rates may have to rise to stop the economy from overheating. The U.S. has already unleashed trillions of dollars in government stimulus spending, and the Biden administration plans to spend trillions of dollars additionally on infrastructure investment. The release of such a huge amount of money will inevitably lead to inflation. Nevertheless, high officials of the U.S. administration would refrain from mentioning interest rates. Therefore, Yellen’s recent remarks are considered rather unusual. Apparently influenced by her rate hike warnings, the Nasdaq fell nearly 2 percent. 

Rising prices around the world are putting pressure on central banks, which will find it difficult to maintain the low-interest rate trend if prices continue to go up. Inflation will deal a blow to public livelihoods, as it dampens households’ spending power and reduces net income to deteriorate living standards. That’s why inflation is described as “a tax levied on poor people.” 

When prices soar, central banks choose to control money supply by raising their key interest rates. Central banks have released an enormous amount of money to tackle the fallout of the pandemic. Now, they are carefully watching the movement in consumer price trends. Markets are also anxious about when central banks will normalize their expansionary policies, faced by growing inflationary pressure. 

Economic experts in the U.S. are concerned about excessive inflation. According to the Wall Street Journal, most economists predict that spending will continue in the months ahead to build inflationary pressure. Citibank has forecast that the Fed will scale back or “taper” its asset purchases in the fourth quarter of this year, with an interest rate hike expected at the end of next year. The Fed remains circumspect about changing its current monetary policy, since the U.S. economy has yet to fully recover. But if market interest rates rise, the Fed will inevitably have to consider its own rate increase. It seems important to pay attention to inflation-related indicators, such as consumer prices and employment trends.

Central banks will unlikely to raise their key interest rates anytime soon, but it seems the mood for a rate increase is being formed gradually. If the U.S. lifts its policy rate, South Korea should follow suit, even if its economy has not fully recovered yet. A rise in the key interest rate might hamper the Korean economy, which has just managed to rebound on the back of various pump-priming measures. A higher interest rate may deal a direct blow to heavily indebted households and companies, in particular. 

Korea’s household debt exceeded 1,700 trillion won or about 1.5 trillion US dollars as of the end of last year, up nearly 8 percent on year. The country’s household debt-to-GDP ratio surpasses 100 percent. No doubt, higher interest rates will have a devastating impact on indebted individuals and small businesses. 

Financial markets will be in an even more serious situation. If the past is any guide, a rate increase in the U.S. would prompt U.S. funds in global markets to return to the U.S. If that happens, emerging markets, including South Korea, will be hit hard. They will also have to raise their own interest rates to prevent foreign capital from flowing out. But they should deal with the problems of an economic slowdown and the burden to pay back debt. 

Considering Korea’s staggering household debt, an interest rate increase could be another “detonator” of a bomb for the local economy. Korea finds it challenging to catch up with economic recovery in the U.S., due to the slow progress in the vaccine rollout. If the U.S. drops its loose monetary policy and seeks to raise its interest rate, the Korean economy will be in great shock. That’s why the country needs to carefully watch the global economic trends. 

The government says that prices may go up for the time being, but the annual inflation is unlikely to exceed the central bank’s target of 2 percent. Yet, inflation could accelerate even further, due to ample liquidity, economic recovery momentum and rising consumption. Given the pandemic-related risk factors, it is difficult to change the policy stance of monetary easing right now. Still, Korea has to adjust the level of household debt and national debt, in preparation for a rate increase, which, along with rising prices, places a significant burden on the general public, especially small businesses and self-employed people who relied on loans to overcome the COVID-19 crisis. It’s necessary to devise preemptive measures to protect the vulnerable groups. 

The Korean economy has been in a low growth, low inflation trap for years. Fortunately, it grew 1.6 percent on-quarter in the first three months of the year, ready to escape the long tunnel of recession. In this situation, upward inflationary pressure is one of the major risk factors. 

The government needs to handle the growing concerns over inflation preemptively, while households and companies have to manage their debt at an appropriate level, having the possibility of a rate increase in mind.