Fixed Income Weekly
The author is an analyst for NH Investment & Securities. He can be reached at sw.kang@nhqv.com -- Ed.
Following revision of the price basket housing component to a new contractual basis, core inflation has plummeted. The culprit behind core inflation rigidity has now gradually come to be seen as being housing cost. The gap with headline core inflation should narrow in 2H23 as price basket housing cost also begins to drop.
Housing cost viewed as main culprit behind core inflation rigidity
In Nov 22, Powell divided inflation into three categories: 1) goods; 2) housing; and 3) services, with service inflation being the most important factor. He identified non-housing services inflation as being the best indicator of underlying demand for services. This indicator is now showing an eight-month descent, with the pace of m-m decline standing out. Sticky inflation (excluding housing) has also fallen for eight consecutive months. At least service prices are showing evidence of stabilizing (as the Fed intended).
Despite the stabilization of services prices, key Fed officials (including Powell) remain concerned over the stiffness of underlying inflation. The University of Pennsylvania has released a new contract-adjusted price index for housing that considers the fact that the housing component of the price basket has a time lag with the new contract basis. Unlike the original headline inflation rate, the housing-adjusted headline inflation rate has plummeted. In the end, housing cost is judged to be the main culprit behind core inflation rigidity, and Powell's final task is to confirm a decline in housing cost.
Starting in Mar 2021, the housing cost growth component in the price basket rose for 25 months in a row before slowing over Apr~May 2023. Housing cost on a new contract basis has fallen for 15 straight months (since Feb 2022). Given such, we expect the price basket housing component to continue on a downward trend in 2H23, in turn narrowing the gap between core and headline inflation. Moving ahead, it will be important to confirm a drop in housing cost, the final task of Powell’s initiative.
Key message of BOK anniversary speech: Differentiation to be in play
The BOK’s recent anniversary speech conveys the important monetary policy message that, unlike last year, monetary policy conditions are to differentiate across countries, making a sophisticated policy response crucial. In its June Monetary and Credit Policy Report, the BOK noted that, unlike in major economies, Korean service sector wages did not change notably between before and after the pandemic, and that labor market explanations for underlying service prices were not significant (36.6% in US versus 16.7% in Korea). Unlike in outside major economies, the second-round effects of the 2022 import price spike were important in driving up core inflation in Korea. While the dollar/won rate has stabilized rapidly in recent months, imported inflation has been in reverse growth (in won-denominated terms) for four consecutive months, extending its downslide. Korean core inflation is to continue narrowing the gap with the headline rate.