War's lingering legacy: Despite Hormuz reopening, inflation, high rates and strong dollar may be new normal 

The new U.S.-Iran cease-fire agreement may unblock the Strait of Hormuz and ease immediate concerns over global energy supplies, but economists warn that high inflation, high interest rates and a strong U.S. dollar could perpetuate a cycle of economic pain long after the guns fall silent.

The United States and Iran reached an interim agreement on Sunday to end the conflict and reopen the Strait of Hormuz, which has been effectively blocked for more than 100 days. The deal is slated to be signed on Friday.

The news is a welcome reprieve, as hundreds of oil tankers and commercial vessels, including two dozen Korean ships, are expected to gradually begin to pass through the waterway again if the agreement holds. 

If oil-producing countries that were forced to cut output restore production to normal levels, the current concerns over energy supply shortages could be alleviated quickly. Upward pressure on shipping rates and insurance premiums is also likely to ease.

However, the economic scars of the conflict are expected to outlast the fighting itself as inflation has surged, interest rates have climbed and the U.S. dollar has strengthened sharply. 

Global oil prices are already elevated. 

U.S. West Texas Intermediate (WTI) crude futures traded on the New York Mercantile Exchange remained in the $90 to $100 per barrel range throughout last month. That is far above prewar levels, when WTI traded at around $60 per barrel before the conflict began on Feb. 28.

Analysts say expectations that oil prices will revert to prewar levels by the end of this year amount to little more than wishful thinking. The Korea Energy Economics Institute forecast that crude prices would remain above $90 per barrel for several months even after a cease-fire agreement.

Even if the strait opens, getting stranded vessels safely out of the waterway is expected to take months. 

Oil prices matter because they are a key barometer of inflation. They affect not only manufactured goods but also logistics costs, dining expenses and public utility charges.

Korea’s producer price index rose 2.5 percent in April from March, marking the largest monthly increase since February 1998 during the Asian financial crisis, when it also rose 2.5 percent.

“Producer prices are typically reflected in consumer prices with a lag of one to three months,” said Joo Won, head of research at Hyundai Research Institute. “From the second half of the year, we are likely to see the inflationary effects of the war appear.”

When inflation rises, central banks typically respond by raising interest rates. That means the era of high interest rates is unlikely to end soon.

Market participants saw a greater-than-70 percent chance that the U.S. Federal Reserve would raise interest rates by at least 0.25 percentage points by December, according to CME FedWatch Monday.

That marks a sharp reversal from a month earlier, when the probability was close to zero.

“If the Fed adopts a more aggressive tightening stance than expected, the Bank of Korea [BOK] will inevitably face pressure to raise rates as well,” said Kang Sung-jin, a professor of economics at Korea University.

BOK Gov. Shin Hyun-song also hinted at raising rates during the central bank’s first Monetary Policy Board meeting under his leadership on May 28.

“The direction ahead is relatively clear when considering inflation, growth, exchange rates and the property market,” Shin said. “The question is when, how quickly and how far rates should be raised.”

Market participants broadly expect the next Monetary Policy Board meeting on July 16 to result in a benchmark rate increase.

While high inflation and high interest rates are global phenomena, the won has plummeted against the dollar, compounding the pressure on Korea's economy.

The dollar-won exchange rate, now commonly sitting at above 1,500 won per dollar, could remain there for an extended period.

Excluding the 1997-98 Asian financial crisis and the 2008 global financial crisis, this year marks the first time the exchange rate has exceeded 1,500 won.

“Continued selling of Korean stocks by foreign investors is limiting the range for the won to strengthen,” said Lee Jung-hoon, a research fellow at Daishin Securities. “It will be difficult for the won to enter a sustained appreciation cycle before the Fed begins making significant rate cuts.”

Kim Sang-bong, a professor of economics at Hansung University, also echoed that the risk following high inflation, high interest rates and a strong U.S. dollar will continue even after the conflict ends.

He stressed that, in the short term, controlling inflation should be the top priority, while aiming to raise the nation’s potential growth rate over time.

“Over the longer term, Korea must raise its potential growth rate, which has fallen to the upper 1 percent range, through structural reforms in regulation, pensions, education and labor,” Prof. Kim said.

BY KIM KI-HWAN   [[email protected]]