Inflation in South Korea spiked last month to its highest since the 1997-98 Asian financial crisis – an outcome that could force the central bank to raise interest rates.
The consumer price index grew by a slightly faster-than-expected 6.0% in June over a year earlier, the highest since November 1998, data showed on Tuesday.
Other data showed foreign exchange reserves shrank by the most since late 2008.
Analysts dismissed risks of the country falling into a crisis, thanks to the improvements in Korea’s balance of payment and debt profile.
But some warned the government and central bank were facing a difficult period.
“Policymaking will become all the more difficult as they have a mix of upside inflation risks and downside economic growth risks continuing for the time being,” Park Seok-gil, an analyst at JPMorgan Chase Bank, said.
Vulnerable To External Shocks
The high inflation reading did reinforce the case for the central bank to increase of the policy interest rate by an unprecedented 50 basis points at its meeting next week.
South Korea’s vulnerability to external shocks, given its heavy reliance on foreign trade and cross-border capital flows, has seen it come under pressure with rising fund outflows from the local stock market and the falling value of the won.
Reflecting the strain, the credit default swap premium on the country’s five-year global sovereign bonds has shot up 30.57 basis points this year to 52.54, the highest since the early days of the Covid pandemic in early 2020.
Local financial markets showed no sign of panicking on Tuesday, with a perception that problems the country faces are mostly from abroad and a global trend. Stock, bond and currency markets all posted small gains.
BoK Intervenes in Forex Market
Still, pressure is building on the government of conservative President Yoon Seok-yeol, who started work just two months ago and has yet to provide a broad policy blueprint on how to make a difference from his liberal predecessor.
President Yoon has ordered a reform of the public sector, calling for sell-off of idle assets and savings in expenditure, while promising that he would preside over an emergency meeting on the economy every week.
Since Yoon took office, the central bank has been selling dollars to tame the won currency’s plunge to the weakest since the 2008-2009 global financial crisis from unnerving investors while at the same time dealing with sustained capital outflows from the stock market.
The Bank of Korea said on Tuesday it sold part of its foreign exchange reserves for a fourth consecutive month in June to “ease volatility in the foreign exchange market”, a phrase used to describe its intervention.
It did not disclose how much it sold, but the intervention, as well as the dollar’s spurt against the other major currencies, caused the dollar value of its foreign reserves to shrink by $9.43 billion in June.
Currency traders shrugged off the drop in foreign exchange reserves, saying it was largely expected and also attributable to changes in the dollar’s value, while cautioning that further sharp and disorderly changes could be problematic.
South Korea’s foreign reserves were ranked the ninth in the world at the end of May, and at $438.28 billion, were enough to cover more than seven months of imports based on the monthly average amount for this year.
- Reuters with additional editing by Sean O’Meara