Korea inflation 'on a clear downtrend'

DBS says headline CPI has dropped to 2.2% YoY in June, the lowest so far this year.

DBS Group Research noted:

GDP growth should have decelerated to mid-2% (QoQ saar) in 2Q, down from 3.5% in 1Q. While industrial production held up better than expected in May (1.1% MoM sa), its sequential growth has remained sluggish on a three month, moving average basis (-1.8% 3M/3M saar).

Moreover, the fact that manufacturing PMI dropping below 50 in June (49.4) suggests that manufacturing growth has again deteriorated last month. Comparatively, the services sector remains resilient (services output: 1.5% 3M/3M saar in May), thanks to domestic consumption demand on the back of a steady labor market and moderating inflation, partly offsetting the headwinds of stock price declines and FX volatilities.

Indeed, inflation is on a clear downtrend, helped by the declines in oil prices. Headline CPI has dropped to 2.2% YoY in June, the lowest so far this year. The actual inflation rate excluding fiscal subsidies provided by the government earlier this year is estimated to be in the range of 2.5-3.0% at present. This is slightly lower than the long-term inflation average of 3% or the middle point of the central bank’s target of 2-4%.

Given the benchmark interest rate standing at 3.25%, there should be space for the Bank of Korea to cut rates by 50bps to stimulate domestic growth without creating economic imbalance. That said, the BOK would be inclined to save policy options, as the risk of a sharp economic slump resulting from shocks in Europe has subsided for now, while the risk of a renewed deterioration in European debt crisis remains high. We expect the BOK to stay on hold next week.