Bank of Korea expected to hike rates in May as inflation hits 13-year high

Today’s April CPI outcome of 4.8% year-on-year (vs 4.1% in March) was a surprise and was well above the market consensus of 4.4%. The monthly gain (0.7% month-on-month, seasonally-adjusted) has accelerated for five months in a row. Price gains in petroleum (+34.4%) and manufactured food (+7.2%) were most significant on the back of higher energy and food prices, yet the core CPI (excluding agricultural and oils) also rose 3.6% (vs 3.3% in March), the highest since December 2011.

Utilities such as electricity, gas, and water jumped to 6.8% in April (vs 2.9% in March) and are set to increase further throughout this year, to reflect the rise in raw material costs last winter. City gas price hikes are scheduled in May, July, and October while electricity rates will go up in October. The government has suppressed additional utility price increases so far, but given that global energy prices soared even higher this year, eventually, higher bills will be delivered at the end of this year or early next year. We expect higher utility costs to remain through 2023 and the lingering impact will keep CPI above the Bank of Korea's (BoK's) target for 2023.

Service prices also rose firmly in April with the price gains more broadly based. Eating out prices stayed at an elevated 6.6% for the second month, taking a pause after rising sharply in March, while other personal services continued to increase. With the reopening of services in late March, labour-intensive services such as housekeeping, nursing, and apartment management expenses rose significantly, indicating some wage increases in low-skilled services. However, we expect the reopening effect to normalise within a few months, and we do not expect a labour shortage to come yet, so service sector price gains will be adjusted accordingly.

While we expect the headline CPI to rise above 5% in 2Q and 3Q, we expect the monthly gain to moderate gradually in the coming months, mainly for two reasons:

1. The government’s fuel tax cut (expanding the tax cut by 30%), which started this month and will continue for the next three months, will help in slowing down fuel price gains
2. Rents are expected to subside thanks to a mortgage rate hike. Housing rents have shown some signs of moderation, falling to 2.0% (vs 2.1% in January) as mortgage rates for rental have increased since the beginning of the year.

Based on higher-than-expected CPI and better-than-expected 1Q22 GDP results, we think that BoK will probably pay more attention to curbing inflation in the near future. Additionally, our US team now expects the Federal Reserve to deliver a 75bp hike in June after raising 50bp in May, with the terminal rate reaching 3.25% by the end of 2023. As BoK will not hold a policy decision meeting in June, more aggressive Fed hikes increase the probability of the BoK’s rate action in May. Therefore, we expect BoK to announce a 25bp hike in May, July and November. Also, based on recent higher-than-expected price gains in underlying pipeline prices and Korean won depreciation, we are also substantially revising up our annual CPI forecasts to 4.6% (vs current 3.6%) in 2022 and to 3.0% (vs current 2.5%) in 2023.