Persistent 'Uncertainty' Despite Base Rate Hike

Things to Check After the Geumtongwi Meeting

Lee Chang-yong, the nominee for Governor of the Bank of Korea, is arriving at the confirmation hearing office set up in the Booyoung Taepyeong Building on Sejong-daero, Jung-gu, Seoul, on the 1st, and responding to questions from the press. Photo by Joint Press Corps

[Asia Economy Reporter Hwang Junho] Although the Bank of Korea raised its benchmark interest rate on the 14th, various variables such as global central banks' tightening, hawkish remarks from the candidate for the next BOK governor, and capital outflows due to the interest rate inversion between Korea and the U.S. suggest that it is too early to feel relieved. On the 16th, Jaekyun Lim, a researcher at KB Securities, stated, "There are still factors that could increase market volatility."

First, attention should be paid to the confirmation hearing of Lee Chang-yong, the candidate for the next Bank of Korea governor, scheduled for the 19th. Recent remarks by the candidate emphasize managing inflation and household debt over growth. Although household loans have declined for four consecutive months, the next government has hinted at easing loan regulations, and commercial banks are lowering their additional interest rates. Moreover, while total loans have decreased, mortgage loans have increased. This could lead to renewed emphasis on financial imbalances such as mortgage loans.

In particular, the U.S. Consumer Price Index (CPI) for April, to be released on the 3rd of next month, may be higher than in March, and domestic inflation could also show higher figures in the second quarter. This could strengthen expectations for continuous interest rate hikes. Despite the March CPI reaching a 40-year high, which has led to excessive perceptions that inflation has peaked and that U.S. monetary policy will ease, the market is taking the possibility of a 50bp hike at the May FOMC as a given. Even after the March inflation release, Federal Reserve Governor Waller and New York Fed President Williams continued to support a 50bp hike in May.

This month, the Reserve Bank of New Zealand (RBNZ) tightened monetary policy, raising concerns about the Reserve Bank of Australia’s (RBA) moves in May. At its April monetary policy meeting, the RBA indicated a shift toward tightening. Furthermore, since New Zealand and Australia are geographically close and have shown similar monetary policy trends, caution regarding the May RBA monetary policy meeting is expected to increase.

Concerns about capital outflows due to the inversion of benchmark interest rates between Korea and the U.S. may also rise. If the Bank of Korea raises rates once each in the third and fourth quarters of this year, and the U.S. Federal Reserve raises rates by 50bp in May and June and by 25bp at every meeting in the second half of the year, the Korea-U.S. benchmark interest rates will be equalized at 1.5% in June, and the inversion gap will widen to 50bp by the end of the year. When the interest rate inversion occurs, there are forecasts of rapid capital outflows by foreign investors in the domestic bond market. However, as explained by the BOK governor candidate and Acting Monetary Policy Committee Chairman Joo Sang-young, the possibility of rapid capital outflows by foreigners in the domestic bond market is low despite the Korea-U.S. interest rate inversion. Korea’s credit rating, economic recovery trend, and fundamentals are excellent, making rapid withdrawal unlikely. Not only are there foreigners seeking simple interest rate differentials, but there is also demand for carry trades through currency hedging, and considering this, Korea’s short-term bond yields are expected to remain advantageous compared to those of the U.S.

Researcher Lim said, "If these variables actually come into play, continuous interest rate hikes may occur," and "Acting Chairman Joo Sang-young mentioned that Korea’s benchmark interest rate cannot be raised above the neutral rate, but the final upper limit of the benchmark rate could rise from the existing 2.25~2.50% to around 2.75%."

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