Powell's Giant Step Entangles Korea's Interest Rate Equation [The Editors' Verdict]

[Image source=Yonhap News]

The global food price index hits an all-time high, the neutral status is abandoned for the first time in 70 years, consumer prices soar to the highest in 41 years, and the base interest rate is raised by 0.75% for the first time in 28 years... Reading recent headlines, one truly feels that we are living in a historic moment.

The Russian invasion of Ukraine, which erupted before the COVID-19 pandemic (global pandemic) had even ended, is leading the global economy into uncharted territory never before experienced. Inflation stemming from the food and energy supply crisis is especially severe. To quote U.S. Treasury Secretary Janet Yellen, prices have reached an "unacceptable level."

To curb inflation, the U.S. Federal Reserve (Fed) took a giant step (a 0.75% base interest rate hike at once) for the first time since November 1994. Fed Chair Jerome Powell has left open the possibility of another 0.75% hike in July.

Most experts expect the U.S. economy to fall into recession due to the Fed’s steep interest rate hikes. The fear of this has caused significant shocks in global financial markets. The ultra-tightening will not be limited to the U.S. On the 16th, when the U.S. announced the giant step, the Swiss National Bank (SNB) surprised economic experts by raising its base interest rate by 0.50%.

Such movements will ripple through our economy via various channels.

First to consider is capital outflow. When former Fed Chair Alan Greenspan took a giant step 28 years ago, Latin American countries like Mexico experienced economic crises. Three years later, in 1997, crises hit Asian countries such as Thailand and the Philippines, and the aftermath led to Korea’s IMF foreign exchange crisis. In the following year, 1998, Russia declared a moratorium (debt payment suspension).

This time, the crisis will also emerge from the weakest links. Sri Lanka, which has already declared national default, has a small economy and thus does not cause a global shock, but if problems arise in emerging countries like Turkey and Pakistan, the situation will be different.

The asset collapse triggered by rapid interest rate hikes is a ticking time bomb whose explosion timing is uncertain. Fixed mortgage rates have already exceeded 7%, with forecasts suggesting they could reach 8% by year-end. If the real estate market collapses, Korea will suffer an economic shock incomparable to stocks or cryptocurrencies.

Companies that increased debt during COVID-19 are also in emergency. “Zombie companies” produced by low interest rates and various government policies will undergo restructuring. Even sound companies will suffer from sharply increased financing costs.

As central banks around the world withdraw liquidity, the global economy will contract. Korea’s export-dependent economy could be hit directly. Moreover, the recent economic situations of neighboring countries are not entirely favorable. The Bank of Japan (BOJ) continues its accommodative policy despite the weak yen. China, experiencing economic slowdown due to COVID lockdowns, is also continuing to inject money.

Korea’s fiscal and monetary authorities inevitably face deepening concerns. Following the U.S. with big steps will inevitably cause economic shocks, but at the same time, soaring prices cannot be ignored.

Deputy Prime Minister Choo Kyung-ho diagnosed the current situation as a “complex crisis.” Whether this crisis can be overcome without major shocks depends on Korea’s current economic resilience. The government and monetary authorities should reflect on the fundamental strength of our economy and whether it has fallen into populism.

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