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Inflation flares in Asia, to pressure central banks

SEOUL - Inflation in South Korea and Thailand accelerated to its fastest pace since the 1998 Asian financial crisis, pressing their central banks to join a regional scramble to contain price pressures.

Thailand is likely to raise interest rates for the first in two years next week following an expected hike in Indonesia on Thursday. A rate rise in South Korea is less certain.

India, Taiwan and Philippines raised rates last month and China will likely hike rates at least once this year after a series of increases in bank reserve requirements, a Reuters poll shows.

Inflation pressures are on the rise globally. The European Central Bank is widely expected to raise rates on Thursday and the U.S. Federal Reserve is expected to raise rates by the end of the year following an aggressive cutting cycle to ward off the impact of the global credit crisis.

In Asia, rising costs have made government subsidies on oil and food unsustainable, forcing several countries including India, Malaysia and Indonesia to raise domestic fuel prices. Bangladesh joined their neighbours on Tuesday, raising various fuel prices. Pakistan ramped up natural gas prices on Monday.

Annual inflation in South Korea rose to 5.5 percent in June, up from 4.9 percent in May. The figure was broadly in line with expectations but underlined the growing price pressures in Asia's fourth-biggest economy.

The central bank forecast that inflation for the year as a whole would also be a 10-year high but that economic growth would weaken to a three-year low, raising the spectre of stagflation and a dilemma for policy makers.

Growth versus inflation

Given a mix of slowing growth and stronger inflation, analysts believe the central bank will lean towards supporting growth by leaving rates unchanged this year.

Economist Oh Suk-tae at Citibank reckons the central bank will raise rates in August or September, but others argued differently although much would be determined by the outcome of data.

"The Bank of Korea will probably keep interest rates steady for this year, but the direction may vary after checking money supply data due next week," said Park Sang-hyun, chief economist at CJ Investment & Securities.

The central bank's next policy meeting is on July 10.

The central bank, which has kept rates unchanged for 10 months at 5 percent, acknowledged the price pressures.

Kim Jae-chun, head of the central bank's research department, said economic growth would begin recovering after the first quarter of 2009, while oil prices, the main driver of inflation, were more likely to rise than fall.

Thailand's annual inflation rate surged to a 10-year high of 8.9 percent in June, above analysts' forecasts, and reinforcing market expectations the central bank will raise its rates for the first time in two years when it reviews policy on July 16.

Inflation expectations

Like central banks globally, Thai policy makers have to assess whether a rise in interest rates would be effective in controlling inflation resulting from supply factors, such as a rise in international oil and food prices, rather than domestic demand.

"The central bank might have to act to try to deflect rising inflation expectations," said Standard Chartered economist Usara Wilaipich.

"With record oil prices pushing up costs, aggressive rate rises would not be that effective for fighting inflation," she said.

Indonesia has similar considerations. Inflation in Southeast Asia's biggest economy rose to a 21-month high above 11 percent in June as the full impact of a rise in domestically controlled fuel prices kicked in, putting pressure on the central bank to raise interest rates again.

Bank Indonesia (BI), which meets on Thursday to review interest rates, declined comment on the interest rate outlook but said it would use both interest rates, currently 8.5 percent, and the rupiah as tools to help contain inflationary pressures.

"Regarding interest rates, we agree with BI that inflation is a cost push, so raising interest rates wouldn't have too much of an effect," said Jakarta-based economist Aldian Taloputra of Mandiri Sekuritas.

"As things stand, we still see a BI rate of 9 percent by year-end, with the next monetary policy to raise the rate by 25 basis points."

Surveys on Tuesday showed commodity costs are seeping through Asian factories to the world's consumers, slicing into Japanese manufacturers' profit and stoking inflation in China and India.