By Kim Jae-kyoung
Staff Reporter
Soaring prices have increased inflation expectations, fanning worries over the advent of the so-called wage price spiral, in which wages and prices chase each other ever upward. Inflation expectations are future inflation forecasts by economic agents.
Under this vicious cycle, a rise in oil and raw material prices raises product prices, which in turn jack up labor costs. The wage increases, in turn, seep into product prices, forcing workers to demand another hike in wages. Once the economy enters this cycle, inflation becomes out of control.
According to the Bank of Korea (BOK), inflation expectations stayed above 4 percent in June year-on-year, well above the central bank's inflation target of 2.5 to 3.5 percent.
The central bank estimates inflation expectations by asking both experts and general people what their forecast for inflation is in the next one year.
``Inflation expectations recently rose above 4 percent. Chances are that people will press for wage hikes if inflation gains further momentum,'' a ranking BOK official said.
The inflation expectations stayed below 3 percent until the third quarter of last year, but increased to 3 percent in the fourth quarter and 3.3 percent in the first quarter of this year.
``What is more worrisome is that inflation expectations have continued on an upward trend,'' the BOK official added.
BOK Governor Lee Seong-tae also raised concerns over a wage price spiral, saying, ``We are concerned about the secondary effect of rising inflation, in which inflation may creep into wages and increase inflation expectations,'' he said.
The central bank said that despite rising inflation, the possibility of a wage price spiral remains low, as labor unions have yet to demand wage increase in earnest due to the stagnant job market.
``Although real income growth has turned negative due to inflation, people seem to care more about job security,'' another BOK official said.
However, market analysts said that the central bank should tighten credit in order to curb inflation expectations and prevent it from morphing into a wage price spiral.
``I thought the BOK should have hiked by 50 basis points last week. Such a move would have calmed inflation expectations, which I think must be the priority for the BOK,'' ING Group chief economist Tim Condon told The Korea Times.
``Governor Lee said inflation would remain above 5 percent for some time. I think high inflation will lead the BOK to hike its rate by 25 basis points in September,'' he added.
Citigroup economist Oh Suk-tae echoed the view, saying, ``The BOK should raise rates to cool economic momentum and stave off a wage price spiral.''
He pointed out that one of the key reasons central banks of advanced economies, including the European Central Bank, have raised interest rates was concerns over a wage price spiral
``Once inflation ― although chances are low ― seeps into wages and thus increases inflation expectations, it will get out of control,'' he added. ``Though the link between prices and wages has become looser lately, it is necessary to take preventive measures to avoid a wage price spiral.''
Consumer prices grew at their fastest pace in nearly 10 years last month, rising 5.5 percent in June from a year ago, the highest since November 1998.