Korea Capital Market Institute

In October 2024, Bank of Korea (BOK) officially initiated a policy shift by cutting its benchmark interest rate. This is a move primarily driven by a decline in headline inflation to the mid-1% range and stabilization of inflation expectations at low levels. According to the Monetary Policy Board’s May 2024 minutes, its members underscored the importance of anchoring inflation expectations,¹⁾ especially following a period of high inflation. The Board warned that if inflation expectations remain unanchored, inflationary pressures could persist, potentially delaying the achievement of the inflation target.²⁾ The October rate cut thus reflects an assessment that the current inflation expectations provide a conducive environment for reaching the target rate. Notably, this focus on managing inflation expectations is not unique to Korean policymakers. In recent discussions, policymakers in major economies have similarly emphasized the need to bring inflation expectations under control as the “last mile” in executing a monetary policy shift.³⁾ These discussions have also highlighted the importance of addressing inflation expectations with an understanding of their specific formation mechanisms.⁴⁾

Inflation expectations can be gauged through public surveys, but they can also be assessed using outlooks from professional forecasters. Notably, forecasts from research institutes and financial institutions are often regarded as “informed expectations”, significantly influencing inflation expectations and the decision-making process of other economic agents.⁵⁾ Moreover, financial institutions’ forecasts are typically used as key assumptions in shaping their investment strategies, thereby serving as valuable indicators for anticipating future financial market trends. Recognizing this importance, research on inflation expectations of professional forecasters has been actively conducted in major economies; however, this line of research is scarce in Korea. Against this backdrop, this article analyzes consumer price inflation forecasts for Korea provided by professional forecasters⁶⁾ and examines key characteristics and their implications.


Growing divergence in post-pandemic inflation expectations

Distributions of inflation forecasts at the beginning of each year reveal a growing divergence among economic forecasters since the Covid-19 pandemic. Figure 1 illustrates the distribution of inflation forecasts in the first quarter of each year.
  According to the distribution presented, the cross-sectional standard deviation of first-quarter forecasts (indicated as “SD” in the graph) widened from around 0.2 percentage points between 2018 and 2020 to 0.3-0.6 percentage points in subsequent years. In 2022, a year marked by exceptionally high inflation, the distribution flattened with greater deviations, indicating substantial differences among forecasters. During this period, domestic consumer prices had been rising since the latter half of 2021, and uncertainty over the persistence of this upward trend heavily influenced economic outlooks. Forecasters held differing views on whether high inflation would continue throughout 2022, and the magnitude of forecast changes also varied widely, resulting in the distribution shown in Figure 1.


Reasonable expectation adjustments

Despite widening discrepancies in forecasts, forecasters seem to have consistently integrated inflation-related data into their expectations. If they remain attentive to key information such as published CPI, updated forecasts would likely converge toward ex-post actual inflation over time. The assumption is supported by the data.
  Figure 2 depicts the monthly trajectory of inflation forecasts released by forecasters, displaying the median (solid line) and the 5% range of the upper and lower bounds (dotted lines) alongside the actual inflation rate on an annual basis (solid line). These forecasts are revised continuously over the year, revealing a notable pattern: initial forecasts at the beginning of the year show significant deviations from ex-post actual inflation, while subsequent adjustments steadily bring forecasts closer to the actual inflation. As illustrated in Figure 2, both the median and the upper- and lower-bound forecasts exhibit large initial discrepancies at the beginning of the year but tend to align with actual annual inflation as the year progresses. This common pattern implies that forecasters have updated their predictions on a monthly basis, with attention to latest inflation data. If their predictions disregarded current inflation trends, it would be unlikely to see this consistent convergence pattern of both the median and upper- and lower-bound forecasts toward ex-post actual inflation. This indicates that forecasters are producing meaningful outlooks by incorporating relevant up-to-date information.


Persistence of inflation expectations and impact of actual inflation

An analysis of inflation expectations across forecasting horizons suggests that forecasters base their expectations on the persistence of inflation to a large extent. This is evident in the relationship between forecasts for the current year (Y) and the following year (Y+1), as shown in Figure 3.
  Figure 3 groups forecasts by year, displaying pairs of Y and Y+1 inflation forecasts provided by each forecaster from January to December. A strong positive correlation emerges between these two periods in the figure. That is, for any given year,⁷⁾ a higher inflation forecast for Y is often associated with a higher forecast for Y+1. Also prominent is an upward sloping pattern in groups of forecasts by year. As shown in Figure 3, these forecast groups form clusters by year that exhibit an upward trajectory. This pattern indicates that inflation forecasts for both Y and Y+1 are revised in the same direction at each prediction point.⁸⁾ These features suggest that forecasters tend to view inflation as substantially persistent and form their expectations on the assumption that current trends are likely to continue. If inflation were considered transitory, forecasters would have anticipated a reversion to certain levels by lowering inflation forecasts for Y+1 even when inflation expectations for Y are high. In such a case, the strong positive correlation observed above would likely be less pronounced.
  These findings are further corroborated by an empirical analysis that controls for other covariates.⁹⁾ Table 1 presents estimation results on the relationship between inflation forecasts for Y and Y+1 and each explanatory variable. In the first row of Y forecasts, a significant positive correlation emerges between Y forecasts and published inflation rates. This suggests that forecasters have adjusted their projections for Y in alignment with monthly consumer price data. Similarly, the second column of Table 1 shows a positive coefficient between Y+1 forecasts and published inflation rates, indicating that when actual inflation is high at the time of projection, forecasts for Y+1 are revised upward accordingly.¹⁰⁾ This pattern implies that forecasters interpret current inflation drivers as likely to have a sustained impact on future inflation.


Implications

Despite the increased divergence among forecasters regarding the post-pandemic inflation outlook, their projections warrant careful consideration in terms of seriousness. Inflation forecasts generally converge toward ex-post actual inflation rates throughout the year, suggesting that forecasters seriously reflect inflation-related data in their outlook. If these forecasts disregarded prevailing inflation conditions, they would have deviated substantially from actual annual inflation rates.

Meanwhile, the positive correlation between Y+1 forecasts and published inflation rates carries key implications. First, forecasters incorporate recent inflation trends into their projections, even on a one-year or longer horizon, which underscores the importance of a track record explicitly shown by inflation indicators to manage medium-term inflation expectations. Therefore, if inflationary pressures intensify, a decisive policy response may be necessary to break a reinforcing cycle between actual inflation and inflation expectations.

On the other hand, the positive correlation described above also implies that if inflation stabilizes downward, it could create favorable conditions for a shift toward a more accommodative monetary policy stance. Notably, with recent data indicating price stability, medium-term inflation expectations are likely to remain stable, providing additional flexibility for monetary policy to shift focus away from strict inflation control.

Furthermore, the stabilization of inflation expectations is expected to keep the real policy rate elevated,¹¹⁾ highlighting the necessity for further policy easing. However, as BOK recognizes the need to adjust the pace of easing in response to exchange rate dynamics and financial stability,¹²⁾ it is anticipated to alternate between rate cuts and pauses rather than pursue a continuous series of cuts. This approach could increase uncertainty over the timing and scale of further adjustments. Market participants should remain attentive to the resulting volatility, while BOK should provide clear guidance to mitigate impacts on the market or excessive expectations.

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1) If inflation expectations are not stabilized, additional price increases may occur through wage growth and price hikes, potentially leading to a vicious cycle that further raises inflation expectations.
2) Bank of Korea (BOK), 2024, Minutes of the 10th Monetary Policy Board Meeting for 2024.
3) Financial Times, 2023.12.12, Is the last mile really hardest?.
4) International Monetary Fund, 2023, World Economic Outlook: 2023 October.
5) Carroll, C. D., 2003, Macroeconomic expectations of households and professional forecasters, Quarterly Journal of Economics 118(1), 269-298.
6) This article uses inflation forecast data collected by Bloomberg on a monthly basis (from January 2018 to December 2023, with distribution data extending through March 2024) from domestic and global forecasters. Of the 45 forecasters providing forecasts between January 2018 and December 2023, 35 are financial institutions, 10 are non-financial institutions, with 3 being domestic institutions and 42 foreign. For further details on this data, refer to Kang & Jang’s KCMI issue paper, “Dynamic characteristics of macroeconomic forecasts and the influence of Bank of Korea” published in 2024.
7) For example, in Figure 3, the series marked with an asterisk (*) shows the forecasts for 2022 and 2023 as presented in 2022.
8) In the case of 2022, the current year forecast for 2022 was revised upward compared to the current year forecast for 2021 presented in 2021. Similarly, the following-year (2023) forecast presented in 2022 was also revised upward compared to the following-year (2022) forecast presented in 2021.
9) This analysis focuses on the relationship between inflation forecasts for the current and following years and year-to-date changes in the consumer price index (published CPI). In this context, fixed effects for forecasters and years, 3-month WTI futures price changes, KRW/USD exchange rate changes, the call rate, term spread (3-year KTB yield minus call rate), and the KOSPI Volatility Index (VKOSPI) were controlled. For further details, refer to Kang & Jang (2024).
10) Although not included due to space limitations, published inflation rates exhibits a positive (+) correlation between both current and following year’s forecasts, even when external factors such as the US Consumer Price Index increases and the Industrial Production Index growth rate are added, or monthly fixed effects are controlled.
11) Typically, the real policy rate is calculated by subtracting expected inflation from the nominal policy rate.
12) See the governor’s answer given at the October 2024 press conference on the monetary policy stance.