ECONOMY | Staff Reporter, Korea

Korea’s inflation ends 2011 on a bad note

The country’s inflation remained stubbornly high, up 4% in December.

However, this will not last as HSBC expects price pressure to come down next year on the back of weaker economic activity and lower commodity prices.

Here’s more from HSBC:

Headline inflation remained stubbornly high in December. But this will not last. Price pressures will come down next year on the back of weaker economic activity, lower commodity prices and a strong base effect from this year's high inflation print. Thus, we maintain our call for a 25bp policy rate cut by the Bank of Korea to support growth in 1Q 2012.

December headline CPI rose by 4.2% y-o-y, unchanged from November's reading. This was above market and our expectations. On a m-o-m sa basis, inflation rose by 0.4%, up from 0.1% previously.

Core inflation rose by 3.6% y-o-y in December, slightly up from 3.5% in the previous month.

Average inflation over 2011 was 4.0%. Breaking down the components shows that the top three contributors were 'food & non-alcoholic beverages', 'transportation' and 'housing, water & fuels'.

Looking into 2012, headline CPI is set to come down on the back of lower commodity prices. Furthermore, input costs faced by manufacturers have started to moderate. This will keep the lid on price pressures as producers fight for new business amidst tough economic conditions.

Over the immediate horizon, a strong base effect will pull down upcoming inflation readings. This is largely due to the outbreak of high pork prices from the foot-and-mouth outbreak back near the start of 2011. Given domestic supply of pork has stabilised around October, we expect CPI to come down sharply on a y-o-y basis.

The latest consumer survey by the Bank of Korea showed that inflation expectations have declined. Prices are expected to rise by 4.0% over the next twelve months in December, down from the 4.1% projected in November. We believe there is significant scope for further downward movements. This reflects the lagged movements in inflation expectations formed by consumers to headline CPI readings.

With headline CPI set to stay firmly within the Bank of Korea's target band in 2012 and inflation expectations to follow suit, albeit at a slower pace, the Bank of Korea will have room to support growth by easing monetary policy. We maintain our call for a 25bp policy rate cut by the end of 1Q 2011.

Bottom line
Headline CPI will be coming down, even if today's reading stayed stubbornly high. The drop will be particularly sharp at the start of the year, allowing the Bank of Korea to cut rates and support growth sooner, especially when economic activity particularly vulnerable over the first quarter. Barring any extreme disasters, inflation concerns will be over very soon. Time to start focusing on growth.

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