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South Korea’s inflation rate fell to its lowest level for 12 years last month, underscoring the impact of faltering global consumption on the export-focused economy.

Consumer prices rose by 1.2 per cent in the year to August, the government announced on Monday: a lower figure than forecast by economists, and the latest in a string of data showing flagging momentum in the economy as its key export markets stutter. Consumer inflation has been steadily falling this year from a level of 3.4 per cent in January.

“The way that Korea works is that weak exports sooner or later spill over into weak domestic demand and low inflation,” said Erik Lueth, an economist at the Royal Bank of Scotland. “I think we’ve now hit the low point, and I don’t think we’re heading into a deflationary environment …but I expect inflation to remain weak.”

On Saturday trade figures showed a 6.2 per cent annual fall in exports: the sixth decline in eight months. South Korea’s exports to the EU have been severely hit by the region’s economic crisis, and demand from other key markets such as China and the US is also struggling.

South Korea’s large, export-oriented manufacturing sector – last year’s merchandise exports of $552bn amounted to 49 per cent of gross domestic product – means that the country is tightly geared to global conditions, with deteriorating consumption overseas swiftly delivering knock-on effects to the South Korean economy. 

In July the Bank of Korea downgraded its full-year growth forecast from 3.5 per cent to 3 per cent, but economists warn that even the revised prediction could prove optimistic, as confidence wanes among both consumers and businesses. 

The low inflation rate – now well below the Bank of Korea’s stated target range of 2 to 4 per cent – may give policy makers scope for more aggressive intervention to support the economy. It cut the base rate in July by 25 basis points to 3 per cent, and economists are expecting a further cut of the same size to follow this month. Further easing is seen as a possibility, given that the inflation-adjusted base interest rate would be more than 1.5 per cent even after a second cut this month.

However, the BoK is likely to keep one eye on a possible resurgence of inflationary pressure, said Ronald Man, an economist at HSBC. Core inflation, stripping out the prices of agricultural products and oil, rose from 1.2 per cent to 1.3 per cent last month: a sign that inflation could still flare up in the medium-term, said Mr Man.

Senior government officials privately dismiss the likelihood of a major fiscal stimulus in the near future, arguing that it is vital to preserve ammunition in case of a more serious deterioration in the economy.

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