Markets Cheer Peace Prospects, but Inflation Risks Point to Tighter Policy

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: Markets may cheer peace prospect, but inflation risks point to tighter policy

Financial markets have a habit of declaring victory before diplomats do. That instinct was on full display Friday, after US President Donald Trump said a deal to end the US-Israel war on Iran could be signed as early as over the weekend.

Stocks rallied across the world, oil prices retreated and South Korea's benchmark Kospi surged 4.63 percent to reclaim the 8,000 mark.

Yet while Washington and Islamabad spoke confidently of an imminent agreement, Tehran urged caution. Investors appear to be pricing in a postwar future before the signatures are in place.

Even if a ceasefire materializes, Korea should resist confusing a reduction in geopolitical tension with a return to economic normality. The more consequential signal came not from the market, but from Bank of Korea Gov. Shin Hyun-song, who has repeatedly warned that interest rates will likely need to rise.

The international backdrop points in the same direction. On Thursday, the European Central Bank raised rates by a quarter percentage point, lifting its key rate to 2.25 percent and becoming the first major central bank among advanced economies to reverse course.

Its decision reflects an uncomfortable truth. The economic effects of a conflict often linger long after the fighting subsides. Energy disruptions have already filtered through supply chains and consumer prices. The ECB now expects inflation to remain elevated while growth weakens, illustrating how inflation can outlast the shock that created it.

Other central banks face similar pressures. The Bank of Japan is widely expected to tighten policy further, while persistent inflation in the United States has all but extinguished hopes of near-term rate cuts.

A global shift toward tighter monetary conditions is no longer a forecast. It is becoming a policy. Korea is hardly insulated from that trend. BOK Gov. Shin has delivered multiple public signals that the case for higher rates is strengthening.

The rationale is increasingly difficult to ignore. Consumer inflation rose above 3 percent in May, reaching its highest level in more than two years. The won remains vulnerable around the 1,500-per-dollar range, raising import costs and reinforcing inflationary pressure. Household lending has accelerated again, supported in part by borrowing linked to stock market speculation.

What makes the situation unusual is that these risks are emerging despite respectable economic growth. Chip exports helped drive first-quarter growth of 1.8 percent. Under normal circumstances, such performance might encourage patience.

Instead, policymakers appear increasingly convinced that inflation and financial risks outweigh the benefits of waiting. Market speculation has even turned to the possibility of a larger-than-usual rate increase or an extraordinary policy meeting before July.

Ironically, a peace agreement could complicate the central bank's task. Lower oil prices and rising asset prices could encourage the belief that easy money is around the corner.

Such optimism would be misplaced. If newly released liquidity flows into leveraged stock purchases or property speculation rather than productive investment, Korea's already heavy household debt burden could become an even greater source of vulnerability.

None of this means higher rates will be painless. Small business owners, lower-income households and heavily indebted borrowers will face rising repayment costs.

Policymakers therefore confront a delicate balancing act. Delay tightening for too long and inflation expectations could become entrenched. Move too aggressively and financial stress could spread through the most vulnerable parts of the economy.

That is why Shin's observation about repairing the roof while the sun is shining deserves attention. A Middle East ceasefire, if achieved, would provide welcome relief. The government and financial regulators should use any breathing room to strengthen safeguards for vulnerable borrowers while tightening oversight of speculative excess.

The real test of economic management begins not when a crisis ends, but when the temptation to relax becomes strongest.

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