A member of the Bank of Korea’s monetary policy committee raised alarm of a deflationary risk in the Korean economy, fuelling market expectations for a cut in the policy rate.

Cho Dong-chul, deemed to be on the dovish side among seven rate-setting members of the central bank policy board, in a press meeting on Wednesday warned of the dangers of a deflationary spiral, a situation of persistent decline in prices due to reduced demand by consumers who put off purchases on expectations for prices to go lower leading to reduction in revenue and supply from producers and eventually a recession.

“Persistent cyclical reduction in demand can cause deflation if the economy encounters unexpected shock,” he said.

The common tool to offset or combat the extraordinary phenomenon of deflation is monetary and fiscal expansion.

The market has been betting on a rate cut since the U.S. Federal Reserve declared a pause in its tightening campaign amid signs of slowdown in U.S. economy and elsewhere, and with inflation hovering at zero territory in Korea throughout this year.

The three-year and five-year government bond has been yielding below the benchmark rate of 1.75 percent as expectations for a rate move escalated after the release of a pitiful data on the first-quarter gross domestic product that surprisingly contacted against the previous quarter.

The three-year government bond finished morning trade Thursday at 1.709 percent and the five-year one at 1.749 percent.

The country’s headline inflation added 0.6 percent against a year ago in April, staying below 1.0 percent for four months in a row. The central bank expected consumer prices would go up to 1.5 percent in the latter half, but Cho was skeptical.

“Even if consumer price gain accelerates, we must study if the trend is sustainable,” he said.

Deflation is considered more dangerous to the economy than inflation as the event led to the Great Depression in the United States and economies like Japan and Hong Kong that experienced the rare phenomenon never fully recovered.

Emphasizing the central bank’s primary role in stabilizing prices, he said keeping the inflation in a target range of 2 percent is a job that only the BOK can do.

Subdued prices and wages despite two double-digit hikes in minimum wage was another deflationary symptom, he said.

Higher labor and production cost cannot translate to retail prices due to subdued demand. Instead employers have to lay people off to keep prices low or close their business, he said.

The next rate-setting meeting is held on May 31.

By Kim Yeon-joo and Choi Mira

[ⓒ Pulse by Maeil Business Newspaper & mk.co.kr, All rights reserved]