Bank of Korea, for now, holds interest rates steady... "Discussion on hikes from August" (Comprehensive Report 2)

Early rate hike stalled by the 4th wave

But not enough to damage economic recovery

BOK maintains 4% growth forecast

Concerns over side effects of ultra-low interest rates such as 1765 trillion won household debt

Market weighs possibility of rate hike at October Monetary Policy Committee

Lee Ju-yeol: "Discussion and review of monetary policy adjustment at August meeting"

[Asia Economy Reporter Kim Eun-byeol] The Bank of Korea (BOK) kept the base interest rate at 0.50% per annum. Although it had signaled a rate hike within the year, the 4th wave of COVID-19 has put the brakes on BOK’s early rate hike plan. With 1,600 new confirmed cases reported on the day, the BOK appears to be taking a wait-and-see approach before raising rates.

On the 15th, the BOK’s Monetary Policy Committee held a meeting on monetary policy direction and decided to maintain the base rate at 0.50% per annum. This marks the ninth freeze since the 'big cut' on March 16 last year (from 1.25% to 0.75%) and an additional rate cut in May last year. At this meeting, Monetary Policy Committee member Ko Seung-beom expressed a minority opinion advocating a 0.25 percentage point rate hike. Typically, after minority opinions emerge, the base rate is raised once or twice in subsequent meetings. Although this may vary depending on the COVID-19 situation, the possibility of a rate hike within the year remains.

Lee Ju-yeol, Governor of the BOK, said at an online press conference immediately after the meeting, "The domestic economy is expected to continue its recovery trend and inflation is likely to maintain a high upward trend for the time being, but uncertainties related to the spread of COVID-19 remain, so we will maintain an accommodative monetary policy stance."

However, he indicated that the option of a rate hike within the year still exists. He expects this year’s economic growth rate to remain around 4% as forecasted in May. Exports and facility investment continue to perform well, private consumption is recovering, and employment conditions have improved.

Governor Lee stated, "From the next Monetary Policy Committee meeting, it is time to discuss and review whether an adjustment to the accommodative monetary policy stance is appropriate." He added, "At the May press conference, I said we would maintain the current accommodative stance 'for the time being,' and two months have passed since then. Although COVID-19 is resurging, considering the economic recovery trend, expanding inflationary pressures, and accumulated financial imbalance risks comprehensively, I think it is time to review this from the next meeting." He also noted that the phrase 'for the time being' was removed from the monetary policy direction statement in consideration of this situation.

The rapid increase in household loans amid prolonged ultra-low interest rates and rising inflation are also reasons why the rate hike option remains on the table. Governor Lee said, "Consumer price inflation is expected to exceed the May forecast path and remain in the low to mid-2% range for the time being," adding, "Core inflation (excluding food and energy prices) is also expected to gradually rise to the mid-1% range." Household debt exceeding 1,700 trillion won and asset concentration phenomena are also cited as grounds for a rate hike. The Monetary Policy Committee emphasized, "Household loans continued to increase sharply, showing the largest increase in the first half of the year, and housing prices maintained a high upward trend in both the metropolitan area and provinces. We will review the COVID-19 developments, changes in growth and inflation trends, and accumulated financial imbalance risks to determine whether to adjust the degree of accommodation."

3rd quarter rate hike delayed by COVID-19 spread

Just half a month ago, there was strong weight within and outside the BOK on the possibility of a rate hike in the 3rd quarter. The likelihood of an August rate hike was high, and some even speculated about a July hike. This was because vaccination was progressing rapidly in advanced countries, and the recovery speed was so fast that concerns about overheating the economy arose. Governor Lee also made clear remarks about a rate hike within the year in his founding anniversary speech and inflation briefing. The BOK and government jointly worked to dispel controversies over conflicting monetary and fiscal policies. The government’s stance was also interpreted as supporting a rate hike within the year.

However, COVID-19 has become a stumbling block. Since July, the situation reversed rapidly, with daily new confirmed cases exceeding 1,600, accelerating the spread. Considering the increased burden on self-employed individuals who have been surviving for over a year by borrowing, raising rates has become a cautious move. Professor Ahn Dong-hyun of Seoul National University’s Department of Economics said, "If the worst-case scenario of continuous COVID-19 spread continues, a rate hike within the year could become difficult," adding, "Whether COVID-19 becomes a short-term or medium- to long-term variable is a key factor."

'October hike theory' resurfaces... August possible if recovery is fast

The market expects that the BOK will not decide on a rate hike at the August Monetary Policy Committee meeting but will make a judgment in October. It is said that the BOK will review the COVID-19 situation and its impact and only after releasing the revised economic outlook on the 26th of next month will it consider adjusting rates.

Experts, however, believe that the 4th wave of COVID-19 will not seriously damage the economic recovery trend. There is a learning effect from COVID-19, and large-scale vaccination is scheduled in the 3rd quarter. Cases of COVID-19 progressing to severe illness after vaccination are also low. Citigroup judged that even if the Korean government strengthens social distancing measures, consumption is generally in a recovery phase, and Korea’s economic growth rate is still likely to exceed 4%.

Above all, the side effects of ultra-low interest rates, such as household debt reaching 1765 trillion won and asset concentration in real estate and stocks, support the possibility of a rate hike within the year. The BOK pointed out in last month’s Financial Stability Report that "Korea’s financial imbalance is at its most vulnerable level since the financial crisis." Household loans in the banking sector increased by more than 41 trillion won in the first half of the year, marking the largest increase ever.

Professor Jeon Sung-in of Hongik University’s Department of Economics said, "COVID-19 volatility causes problems in some sectors, such as dining, sports, and cultural industries, but it does not significantly affect export manufacturing, which is a major pillar of our economy," adding, "The global economic recovery does not seem to be particularly stalled due to the Delta variant." He emphasized, "Since inflation is rising mainly in the U.S., the shock caused by quarantine measures should be addressed by fiscal policy, not monetary policy that affects the entire economy."

Recently, the sharp rise in oil and raw material prices, further fueling inflation, is also a burden for the BOK.

If the BOK raises rates, it will be the first among major Asian countries to do so. The Reserve Bank of New Zealand (RBNZ) has decided to abruptly stop bond purchases, which were part of its quantitative easing (QE) policy, starting from the 23rd. Although it kept the base rate at 0.25%, the cessation of bond purchases is seen as a signal for a rate hike. The Reserve Bank of Australia (RBA) also decided on July 6 to begin the first phase of tapering (reducing asset purchases).

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