Rising Inflation... Interest Rate Hike Within the Year Becomes Visible

Export Value from 1st to 10th This Month Up 40% YoY
Faster-than-Expected Economic Recovery Drives Inflation
Soaring 'Debt Investment' Assets Fuel Interest Rate Hikes
Lee Ju-yeol, BOK Governor: "We Will Prepare to Avoid Shock"

[Asia Economy reporters Eunbyeol Kim, Haeyoung Kwon, and Seonhee Son in Sejong] Interest rates and inflation have been on a downward trend for about 20 years since 2000. According to Statistics Korea's inflation rate data, the average inflation rate was about 3.2% from 2000 to 2010, but it dropped to 1.35% from 2011 to 2020, less than half of the previous decade's average.

In particular, interest rates have not recovered to pre-2008 financial crisis levels. The U.S. applied near-zero interest rates (0.00?0.25%), and South Korea applied a 2.0% rate. Although interest rates were raised several times after the crisis, most countries have not restored rates to pre-crisis levels. Due to the Fourth Industrial Revolution and automation, a prolonged deflationary phenomenon occurred where prices did not rise, and tightening monetary policy was not feasible when inflation was stagnant. However, as the recovery from COVID-19 accelerated and inflation surged, the global trend has shifted toward fighting inflation. Asset prices that soared under low interest rates also contribute to the pressure for rate hikes.

◆Faster-than-expected economic recovery... inflation surges= A key reason supporting the end of the low-interest-rate era is the rapid economic recovery. On the 11th, the Ministry of Economy and Finance stated in the 'June Economic Trends (Greenbook)' that "Recently, our economy has maintained a solid recovery in exports and investment, domestic demand continues to improve, and employment has increased significantly for two consecutive months." Exports, which have been a key factor in South Korea's resilience during COVID-19, have accelerated further this year as advanced countries speed up vaccination. According to the Korea Customs Service, exports from June 1 to 10 reached $17.3 billion, a 40.9% increase compared to the same period last year. Last month, customs-based exports rose 45.6%, marking the largest increase in 32 years.

The rapid economic recovery is accompanied by rising inflation. The Bank of Korea's forecast for this year's consumer price inflation is 1.8%, close to the Bank's inflation stabilization target of 2.0%. In its monetary and credit policy report released the previous day, the Bank of Korea stated, "Consumer price inflation is expected to exceed 2% in the second quarter and fluctuate around 2% in the second half, significantly expanding the upward trend compared to last year." Notably, core inflation, which had remained in the 0% range for the past two years and raised deflation concerns, is expected to rise above 1% this year. The Bank of Korea added, "With short-term inflation expectations rising and the possibility of greater-than-expected inflationary pressures from both demand and supply sides during economic normalization, it is necessary to closely monitor inflation trends."

Since inflation is already rising and inflation expectations that influence future inflation rates are also increasing, the logic for raising interest rates to curb rapid inflation has emerged. The government also mentioned 'inflation concerns' for four consecutive months in the Greenbook. Consumer price inflation rose 2.3% in April and further increased to 2.6% in May. Given that the average inflation rate from January to May was 1.62%, the average inflation rate for the first half of the year is expected to approach the government's annual inflation management target of 2% after June.

◆Serious issues of household debt and asset price surge amid ultra-low interest rates= The surge in asset prices driven by 'debt investment' (borrowing to invest) amid low interest rates has also become a reason to raise interest rates. Bank of Korea Governor Lee Ju-yeol mentioned the side effects of unprecedented economic stimulus measures in his anniversary speech. Governor Lee stated, "The bold economic stimulus measures implemented unprecedentedly were a great help in overcoming the crisis, but it is also true that imbalances between sectors and social classes have widened in the process." He added, "It is an essential process for the stable and sustainable growth of our economy to appropriately adjust the expansive crisis response policies in line with improvements in financial and economic conditions."

According to the Bank of Korea, household debt reached a record high of 1,765 trillion won at the end of the first quarter of this year, roughly equivalent to the size of GDP. As of last year, the household debt-to-disposable income ratio, which indicates households' debt repayment capacity, surged 12.5 percentage points from the previous year to 200.7%. The increase last year was the largest in the past decade. The rapid rise in real estate and stock prices has resulted in widening not only income gaps but also asset gaps.

Governor Lee also expressed his intention to consider the shocks from interest rate hikes. In his speech, he emphasized, "We must carefully examine the COVID-19 developments, the strength and sustainability of the economic recovery, and the accumulated risks of financial imbalances to determine the timing and pace of policy easing adjustments. Of course, during this process, it is necessary to communicate sufficiently with economic agents in advance so that they can prepare without shocks."

This content was produced with the assistance of AI translation services.