South Korea Cuts CPI Target, Pledges to End Low-Inflation Era

  • Central bank sees potential growth rate at just more than 3%
  • Low oil prices causing many countries to miss inflation target

South Korea pledged to end a period of very low inflation that threatens to hurt the country’s economic growth and has now prompted the central bank to cut its target for consumer prices.
The annual pace of inflation has averaged less than 1 percent this year,
compared with the average of 2.7 percent for the prior decade. The Bank of Korea Wednesday lowered its target to 2 percent, from the previous range of 2.5 percent to 3.5 percent.

The Finance Ministry separately cut its growth estimates for 2015 and 2016, and said it will now start monitoring nominal gross domestic product. That measure isn’t adjusted for price changes and offers a better gauge for things like tax receipts and corporate revenue.

Central banks around the world have struggled to hit their inflation targets in the face of persistent declines in the price of oil, and South Korea has been no exception. Record household borrowing gives policy makers another reason to worry about any slip toward deflation, which would increase debt burdens.

Some economists are of the view that Korea’s policy makers should shift their focus from expansive fiscal and monetary actions and that a 2 percent inflation target puts them in the same category as many other countries.

“Having the inflation target around 2 percent would signal that South Korea is structurally an advanced economy, tackling the same problem such as weak domestic demand,” Park Chong Hoon, a Seoul-based economist at Standard Chartered Bank, said before the forecasts were released. “Enough has been done in terms of expanding fiscal policies. What’s left to do is taking the recovery momentum in consumption to next year and boosting exports.”

The central bank, in a briefing, said it plans to focus on tackling low inflation to help propel the recovery.

“The 2 percent goal is adopted by a majority of developed nations including England, Sweden and Canada, and is a target that can encourage stable economic growth,” BOK’s Deputy Governor Suh Young Kyung said. “We consider inflation at 1 percent level as low, and our goal is clearly 2 percent.”

While the BOK will strengthen efforts to reach the inflation target, it does not mean policy actions will follow when price gains trail the goal, Suh said.

Growth Forecasts

BOK’s Suh said the central bank estimates South Korea’s potential growth rate to 2018 will be 3 percent to 3.2 percent.

South Korea’s economy will grow 2.7 percent this year and 3.1 percent in 2016, the finance ministry said in its revised economic outlook, released Wednesday. Both these forecasts were lower than the previous estimates. Consumer prices will rise 0.7 percent this year and accelerate to 1.5 percent next year, the ministry forecast.

South Korea’s consumer price gains have remained below 1 percent for most of this year despite four rate cuts since August 2014 that reduced the benchmark rate to a record low 1.5 percent. Economists surveyed by Bloomberg in September projected the mid-point of the new inflation target would be lowered by a half percentage point to 2.5 percent.

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