South Korean think tank warns of dangers of deflation, rate cuts urged

South Korea's top state-run research institute warned the Bank of Korea yesterday against underestimating the danger of Asia's fourth-largest economy falling into deflation and called on the central bank to cut interest rates.

The Korea Development Institute said in a report that the gross domestic product deflator, a measure of inflation used to calculate economic growth in real terms, had been undercutting the more commonly used consumer price index.

Lee Jae-joon, a director of the institute who wrote the report, said the Bank of Korea needed to further cut interest rates in a pre-emptive response because the country's interest rates were still high when adjusted for inflation.

"The base rate of 2 per cent appears to be low but inflation has never been this low," Lee said, referring to the Bank of Korea's benchmark interest rate that matches a record low first hit in early 2009.

"It needs to be noted that the recent sharp slowing in GDP deflator growth possibly foretells a deceleration in the CPI growth rate."

Central bank data showed the GDP deflator has been growing slower than the CPI in each quarter since the first quarter of 2011, and posted no growth at all in the second quarter of this year over a year earlier.