Nominal GDP surge fuels bets on October rate hike

Nominal GDP — a key indicator Bank of Korea Governor Shin Hyun-song has flagged for the October policy decision — posted its fastest year-on-year growth rate in nearly 47 years, sharpening the focus on where the benchmark interest rate is headed next. Shin delivered a back-to-back rate hike last month but signaled he would take time to assess the impact, yet the major indicators continue to point toward further tightening. With the next meeting roughly a month and a half away, the Monetary Policy Board faces a deepening dilemma.

Second-quarter nominal GDP grew 9.2 percent from the previous quarter, the Bank of Korea said Tuesday. That was a slight moderation from the first quarter's 10.5 percent — the largest quarter-on-quarter gain since the first quarter of 1976 — but on a year-on-year basis, nominal GDP surged 26.4 percent, the biggest annual increase since the third quarter of 1979 (27.7 percent), a span of 46 years and nine months, or 187 quarters.

Nominal GDP measures output at current prices, stripping out the effect of inflation captured in real GDP. Compensation of employees rose 1.9 percent, led by manufacturing, while gross operating surplus jumped 18.5 percent, driven by manufacturing and the finance and insurance sectors. Gross operating surplus posted its largest gain since the data series began. Net production and import taxes fell 6.2 percent — also a record low — as government subsidies expanded.

Real GDP, which adjusts for price changes, grew just 3.7 percent over the same year-on-year period, meaning nominal GDP expanded at more than seven times the pace of real GDP. The widening gap reflects a rapid improvement in the terms of trade driven by a sharp rise in semiconductor prices, which have pushed up export revenues and, in turn, lifted nominal GDP significantly.

Kim Hwa-yong, head of the BOK's national income division, told a briefing on second-quarter national income estimates Tuesday morning that the acceleration in nominal GDP growth resulted from real GDP maintaining a high growth rate while the GDP deflator surged from 12.9 percent in the first quarter to 21.9 percent in the second. The GDP deflator is a broad price index covering all goods and services produced in the economy, reflecting the current price level through the gap between nominal and real GDP. The domestic demand deflator rose 3.6 percent in the second quarter, while the export deflator soared 56.6 percent, underscoring the outsized role of export prices in driving the overall deflator higher.

"Notably, this quarter saw not only a sharp increase in operating profit in the semiconductor manufacturing sector, but also a gradual broadening of earnings improvement to other industries," Kim said.

He added that the rise in gross operating surplus driven by strong corporate earnings would feed through to household income via performance bonuses and dividends, while higher corporate income tax, wage income tax and dividend tax receipts would boost government revenues — ultimately supporting domestic demand with a lag.

Governor Shin has also been emphasizing nominal GDP in recent remarks, arguing that real GDP alone cannot capture income levels or purchasing power, and that nominal GDP more accurately reflects the current trajectory of Korea's economic growth.

The strong nominal GDP reading has added weight to expectations of another rate hike in October. At last month's post-decision press conference, Shin said the board would look at August and September inflation data before the October meeting, calling price indicators critical, and added that the second-quarter GDP estimate — particularly the nominal GDP figures due in early September — would also be a key input.

August consumer prices also came in elevated. Consumer prices rose 3.1 percent year on year last month, according to Statistics Korea. Inflation had run at 3.1 percent in May and 3.2 percent in June before easing to 2.8 percent in July, only to rebound above 3 percent in August. Core inflation — which excludes food and energy — climbed 3.4 percent from a year earlier, the highest reading since May 2023 (3.8 percent), a gap of three years and three months.

The next key variable will be September inflation, due for release in early October. August's reading was significantly boosted by a base effect tied to the billing discounts SK Telecom offered customers as compensation for last year's hacking incident, so September inflation is expected to ease somewhat as that effect fades.

Even stripping out the mobile-billing base effect — estimated at 0.58 percentage point — August inflation remained high, suggesting price pressures could stay elevated. Lee Ji-ho, a BOK deputy governor, said at a price-monitoring meeting on Wednesday that September consumer inflation would come in below August as the base effect dissipates, but that underlying price pressures centered on core items would persist.

Some observers argue that even if September inflation stays high, a third consecutive rate hike would be a difficult call. Shin himself acknowledged that last month's back-to-back increase was unconventional, and he indicated the board would assess the cumulative effects of the consecutive hikes before acting again. Even if the key indicators meet the threshold, the board may opt to pause for one meeting. Doubts also remain over whether semiconductor-driven income gains are broad enough to lift overall domestic demand.

"Because we raised rates consecutively this time, we need to assess the effects," Shin said at last month's press conference, signaling a period of watchful waiting.