Inflation builds momentum as Middle East conflict drives up gas and goods prices

Inflation is showing increasingly unstable momentum. Prices, which had been gradually rising since the second half of last year amid weakening won, surged after the outbreak of the Middle East conflict in late February.

People shop at a local super market in Seoul on April 10. [NEWS1]

Inflation is showing increasingly unstable momentum. Prices, which had been gradually rising since the second half of last year amid weakening won, surged after the outbreak of the Middle East conflict in late February. Starting with gasoline, prices of key everyday goods have been climbing in succession.

Noting concerns about stagflation in the worst-case scenario of the war’s development, the Bank of Korea on Friday decided to freeze the interest rate at 2.5 percent for the seventh straight session. However, government inflation data continues to show a relatively stable rate in the 2 percent range, widening the gap between perceived and official inflation and adding to consumer confusion.

To curb the gradual rise in prices, the government deployed a range of policy measures in the second half of last year. The Fair Trade Commission cracked down on price-fixing cartels involving essential goods such as sugar, flour and eggs, imposing fines of around 400 billion won ($272 million) on the sugar industry. The National Tax Service also uncovered tax evasion cases linked to companies contributing to price pressures. As a result, the annual inflation rate last year remained in the 2 percent range.

Although the March consumer price index (CPI) rose slightly to 2.2 percent due to the impact of the Middle East conflict, it remains in the 2 percent range. However, the inflation experienced by consumers tells a different story.

Even before the conflict, rising restaurant prices and grocery costs in the second half of last year weighed on consumption. During that period, previously frozen university tuition fees and public transportation fares were also raised one after another. That has pushed up personal service prices to 2.9 percent at the end of last year, significantly outpacing overall CPI growth. In March this year, personal service inflation reached 3.2 percent.

Eggs are displayed in a supermarket in Seoul on April 9. The government said it will import 3.59 million eggs and monitor farm-gate prices after establishing a price verification committee in April to as part of efforts to stabilize prices. [NEWS1]

Perceived prices vs the inflation index The gap between perceived inflation and official price indicators largely stems from rising prices in categories such as food and personal services, where consumers immediately feel the impact of price increases.

Last year, the living cost index, which is closely tied to household grocery expenses, rose faster than the CPI. Although it has been on a downward trend since peaking at 6 percent in 2022, it still recorded a 2.4 percent increase, outpacing overall CPI growth. Among the 144 items that make up the living cost index, food-related prices rose 3.2 percent last year, excluding 60 items such as transport, communications and education.

Over a 10-year period, the divergence becomes even more pronounced. According to Statistics Korea on Tuesday, the CPI rose about 23 percent, from 94.9 in 2015 to 116.6 last year. Over the same period, processed food prices increased 32 percent, while agricultural, livestock and fishery products surged 50.1 percent — more than double the overall inflation rate.

Rising prices in essential goods such as fruit, vegetables and meat have significantly increased the burden on consumers. This is also why Statistics Korea publishes supplementary indicators such as the living cost index and the fresh food index, which tracks prices of vegetables, fruit and fish.

Another factor widening the gap between perceived inflation and official figures is the relatively low weighting of frequently consumed items in the CPI basket.

Last year, prices of commonly consumed goods such as garlic (11.7 percent), kimchi (11.5 percent), coffee (11.4 percent) and mackerel (10.3 percent) rose sharply. However, their weights in the CPI remain relatively small — garlic (1.3), kimchi (1.3), coffee (2.6) and mackerel (2.0). As a result, even sharp price fluctuations in these items have only a limited impact on overall CPI calculations.

Finance Minister Koo Yun-cheol speaks during a ministerial meeting held to discuss measures to stabilize inflation at the government complex in central Seoul on April 9. [NEWS1]

Exclusion of key elements

Critics also point to the exclusion of owner-occupied housing costs from the CPI, which only reflects rent and jeonse (long-term deposit leases). This is cited as another reason for the discrepancy, as housing costs have risen significantly in recent years, even as official inflation readings have remained relatively subdued.

Owner-occupied housing costs refer to the imputed value of housing services derived from living in one’s own home, converted into a monetary measure. While Statistics Korea publishes a supplementary indicator that includes these costs, it is calculated based on the estimated rent that would be paid for a similar property if it were leased.

According to the National Assembly Research Service, 19 out of 38 OECD member countries included owner-occupied housing costs in their CPI as of 2023. Statistics Korea plans to seek public input and review whether to incorporate such costs into the CPI later this year. “Excluding owner-occupied housing costs from inflation measures can lead to an underestimation of price increases during periods such as last year,” said Jung Hyung-ki, a researcher at DS Securities.

The gap between perceived and official inflation is also expected to widen further due to the Middle East conflict. The government had projected inflation to remain in the low-2 percent range this year, but the surge in oil prices and exchange rates following the conflict has undermined those assumptions. Last year’s relatively stable inflation reading in the 2 percent range was largely attributed to regulated fuel prices, a condition that has since changed.

In its regional economic outlook released on Monday, the ASEAN+3 Macroeconomic Research Office raised its forecast for Korea’s inflation to 2.3 percent, up 0.4 percentage points from a month earlier.

According to the Korea Center for International Finance, the average inflation forecast among eight major global investment banks — including Barclays, Citi and Goldman Sachs — has also risen from 2 percent at the end of February last year to 2.4 percent at the end of last month.

“Energy shocks stemming from the Middle East have not yet been fully reflected in the data,” said Kim Sang-bong, an economics professor at Hansung University. “If conditions do not improve, inflation could exceed 3 percent."

Prices of everyday necessities are already rising across the board. According to the Korea Agro-Fisheries & Food Trade Corporation, the national average price of 10 large eggs rose 1.6 percent, from 3,934 won in February to 3,998 won in April. For a 30-egg tray, prices climbed 6.9 percent over the same period, from 6,561 won to 7,017 won. Beef prices also surged, with hanwoo (Korean beef) tenderloin rising 24.59 percent on year to 14,336 won per 100 grams.

In Seoul, gasoline prices reached an average of 2,001.54 won per liter as of Tuesday, surpassing the 2,000-won mark for the first since July 25, 2022, when prices spiked in the wake of the Russia-Ukraine war.

Bank of Korea Gov. Rhee Chang-yong speaks to reporters during a press conference following the Monetary Policy Board meeting to keep the rate unchanged at 2.5 percent at the bank in central Seoul on April 10. It was a unanimous decision as geopolitical uncertainty in the Middle East remains high. [BOK]

The government is stepping up efforts to rein in inflation.

The government on Wednesday held an inter-ministerial task force meeting on special management of living costs, chaired by Finance Minister Koo Yun-cheol, and established a principle of freezing central government-controlled public utility fees, including electricity, in the first half of the year.

Local public service fees, including taxi fares, city buses and subway fares, are also subject to the same freeze policy. To support the policy at the local level, the central government plans to seek cooperation from local authorities and expand fiscal incentives. The Ministry of the Interior and Safety has also formally requested local governments to freeze public utility rates.

In addition, the government will apply tariff quotas to 22 key imported food ingredients in the processed food and restaurant sectors and provide 30 billion won in funding support to food service businesses.

“Rising global oil prices are expected to negatively affect consumption and investment by driving up inflation and corporate costs,” said Joo Won, head of the research division at Hyundai Research Institute. “If prolonged, this could simultaneously weaken domestic demand and slow exports, potentially leading to a stagflation-type shock where inflation rises while economic growth stagnates.”

This article was originally written in Korean and translated by a bilingual reporter with the help of generative AI tools. It was then edited by a native English-speaking editor. All AI-assisted translations are reviewed and refined by our newsroom.

BY HWANG JEONG-IL [jin.minji@joongang.co.kr]