Oil, FX, Rates Triple Shock: Korea Most Vulnerable to Stagflation

As the war between the United States, Israel, and Iran shows signs of prolonging, warnings of stagflation—where economic recession and rising prices occur simultaneously—are emerging in markets. Concerns are mounting that if international oil prices and exchange rates surge sharply while Korea's real economy recovery remains weak, soaring prices could weigh heavily on growth.

Unusual signs are already appearing in financial markets. Typically, when war breaks out, global capital flows into U.S. Treasuries, the representative safe-haven asset, pushing bond prices up and yields down. However, in the early stages of the U.S.-Iran conflict, fears of inflation driven by surging oil prices are overwhelming the flight to safety, creating an unusual pattern of falling bond prices and rising yields.

The yield on the 2-year U.S. Treasury rose 10 basis points from 3.37% on September 27—the day before airstrikes began—to 3.48% on October 2. The 10-year Treasury yield also climbed by the same margin to reach 4.03%. As U.S. Treasury yields rose, Korean government bond yields followed suit. In Seoul's bond market that afternoon, the 3-year government bond yield closed at 3.180%, up 13.9 basis points from the previous day, while the 10-year yield finished at 3.594%, up 14.8 basis points.

It is difficult to predict how long this rising rate trend will continue. However, if interest rates climb while prices are already rising due to high oil prices and a weaker won, consumer sentiment could deteriorate sharply. The Bank of Korea raised its growth forecast for Korea this year from 1.8% to 2.0%, with private consumption contributing 0.05 percentage points. A decline in this contribution could deliver an initial shock.

"President Donald Trump has indicated a four-week timeframe to achieve military objectives, but we cannot rule out the possibility of a prolonged conflict," said Yoo Myung-gan, a researcher at Mirae Asset Securities. "If the Strait of Hormuz is blocked and high oil prices become entrenched, stagflation concerns could intensify even within the United States."

Korea's high dependence on crude oil makes it particularly vulnerable to stagflation threats. According to the Hyundai Research Institute, Korea ranked 12th globally in economic size in 2024 but 7th in crude oil consumption. Among OECD member countries, Korea ranked first in oil consumption per $10,000 of GDP at 5.63 barrels.

"Korea's economy is far more dependent on crude oil than major competitors, making it relatively more exposed to inflationary pressures when international oil prices rise," said Joo Won, head of research at Hyundai Research Institute. "If exchange rates also surge and import prices rise, the accompanying decline in the current account balance would have a significant negative impact on economic growth."

The Hyundai Research Institute estimated that if average international oil prices (Dubai crude basis) reach $100 per barrel this year, inflation would rise by 1.1 percentage points. Economic growth would fall by 0.3 percentage points, and the current account balance would decrease by $26 billion. Under an "oil shock" scenario with prices soaring to $150, inflation would surge by 2.9 percentage points and growth would plummet by 0.8 percentage points. The institute noted that annual growth could potentially hover around 1% in such a case—essentially meaning Korea's economy could fall into stagflation.

Foreign institutions' forecasts are even more pessimistic. Citi projected that if international oil prices (Brent crude basis) exceed $82 per barrel for an extended period, Korea's economic growth rate would decline by 0.45 percentage points. Consumer price inflation would rise by 0.6 percentage points this year and 0.12 percentage points next year, the bank forecast.

Academia is also warning of stagflation risks. "If prices jump due to rising oil costs, real consumption could contract further," said Kim Jung-sik, professor of economics at Yonsei University. "As global uncertainty expands and exports take a hit, the slowdown in growth could accelerate."

Experts advised that Korea should focus on securing stable supply chains for crude oil and raw materials in preparation for prolonged Middle East risks, while centering macroeconomic policy on price stability and real economy recovery. "Policies to reduce exchange rate volatility are urgent," said Seok Byung-hoon, professor of economics at Ewha Womans University. "We need measures to prepare for potential volatility expansion from increased margin calls, given the rise in margin trading in the stock market."