[BoK Big Step] Historic First 0.50%p Base Rate Hike... August Big Step Outlook (Comprehensive)

BOK Shows Commitment to Price Stability Through Big Step

[Asia Economy reporters Seo So-jeong and Moon Je-won] The Bank of Korea (BOK) has taken a historic "big step" by raising the base interest rate by 0.50 percentage points at once for the first time ever to curb soaring inflation at its highest level in 24 years. This marks the third consecutive rate hike following 0.25 percentage point increases in April and May, a path the Korean economy has never taken before. With this drastic measure, the BOK has strongly revived its "inflation fighter" instinct, and if it raises rates again at the remaining monetary policy meetings this year (August, October, November), the year-end base rate could reach as high as 3.00%.

On the 13th, the BOK's Monetary Policy Committee held a meeting and raised the base interest rate from 1.75% to 2.25%, a 0.50 percentage point increase. The committee unanimously decided on the big step. During the COVID-19 pandemic, the committee had lowered the base rate to 0.50% in May 2020. It signaled the start of "monetary policy normalization" by raising the rate by 0.25 percentage points on August 26 last year, followed by 0.25 percentage point hikes in November last year, and January, April, and May this year. This time, the rate was raised by 0.50 percentage points to reach 2.25%. While the BOK has previously cut rates three consecutive times, this is the first time in history it has raised rates three times in a row. The BOK had cut rates six consecutive times from 2008 to February 2009 (including emergency meetings) during the global financial crisis.

◆ Inflation expected to peak at the end of Q3 and early Q4 = The BOK tightened monetary policy with this unprecedented big step and three consecutive hikes because the consumer price index in June surged 6.0% compared to a year ago despite two previous baby steps (0.25 percentage point hikes). This is the highest increase in 23 years and 7 months since November 1998 (6.8%) during the Asian financial crisis. The consumer price inflation rate was in the 2% range until September last year, rose to the 3% range by February this year, reached the 4% range in March and April, jumped to the 5% range in May, and broke through the 6% barrier in June.

The problem is that this upward trend has not yet peaked. Financial investment sectors predict that the consumer price inflation rate will soar to the 7% range in October, reaching its peak. If the 7% forecast materializes, it will be the highest level in 24 years since October 1998 (7.2%) during the inflation surge period. Park Seok-gil, Chief Economist at JP Morgan, said, "The consumer price inflation rate will continue in the 6% range in the second half of this year, peak at 7% in October, and then gradually decline."

Inflation expectations among economic agents are also increasing. The expected inflation rate for the next year (general public) rose from 3.3% last month to 3.9%. BOK Governor Lee Chang-yong said, "Since inflation is expected to exceed the target level for a considerable period, it is necessary to continue the rate hike trend," adding, "The magnitude and speed of future rate hikes will be judged carefully by closely monitoring growth and inflation trends, risks of accumulated financial imbalances, changes in major countries' monetary policies, and overseas economic conditions including geopolitical risks."

Experts evaluated this big step as a move by the central bank to demonstrate its determination to stabilize prices amid rapidly spreading inflation expectations. Jo Young-moo, Research Fellow at LG Economic Research Institute, said, "Even if external factors trigger inflation, if inflation expectations spread domestically, it causes a wage-price interaction leading to a vicious cycle," adding, "The big step can lower inflation expectations."

The fact that the interest rate inversion between Korea and the U.S. is becoming more pronounced this month also triggered the big step. With the BOK raising the base rate by 0.50 percentage points to 2.25%, Korea's rate is currently 0.50 to 0.75 percentage points higher than the U.S. rate (1.50?1.75%). However, if the U.S. Federal Reserve (Fed) takes a giant step (0.75 percentage point hike) at the Federal Open Market Committee (FOMC) meeting at the end of this month as expected, the U.S. base rate will be 0.00 to 0.25 percentage points higher than Korea's, reversing the rate order. For the Korean won, which is not a key global currency like the dollar, an inversion or narrowing of interest rates can lead to foreign capital outflows, and the resulting sharp rise in the won-dollar exchange rate can further fuel inflation.

◆ Lee Chang-yong: "Gradual 0.25%p increases going forward" = Now, market attention is focused on the August Monetary Policy Committee meeting. Some cautiously suggest the possibility of another consecutive big step in August to counter high inflation. Ha Jun-kyung, Professor of Economics at Hanyang University, said, "A year ago, inflation was in the 2% range, but now it has jumped to 6%, so we cannot rule out any possibilities," adding, "Although consecutive big steps are very unusual, given the recent exceptional inflation surge, it is necessary to keep the possibility open."

On the other hand, concerns about a global economic recession are growing, and rapid rate hikes could burden the economy. Research Fellow Jo said, "Despite this month's big step, the U.S. is expected to raise rates significantly, so the interest rate inversion between Korea and the U.S. cannot be prevented," adding, "With growth expected to be lower than forecast and a high possibility of economic slowdown in the second half, consecutive big steps will be difficult."

Kim Jung-sik, Professor Emeritus of Economics at Yonsei University, also said, "Even if the U.S. raises rates by 0.75 percentage points causing inversion, unless there are special abnormal signs in the foreign exchange market afterward, I expect baby steps to be taken, and the year-end rate to reach around 3.0%," adding, "Rapid hikes could deepen recession, burst the real estate bubble, and increase interest burdens due to household debt." However, he emphasized that with exports slowing and the trade balance continuing in deficit, and the exchange rate recently hitting new highs, measures to address these issues are urgently needed.

Lee Chang-yong, Governor of the Bank of Korea, is attending the Monetary Policy Committee meeting held at the Bank of Korea in Jung-gu, Seoul on the 13th. Photo by Kang Jin-hyung aymsdream@

At a press conference held immediately after the Monetary Policy Committee meeting, Governor Lee said that it is desirable to gradually raise the base rate by 0.25 percentage points for the time being when asked about the possibility of future big steps. Governor Lee stated, "Since we preemptively raised the base rate by 0.50 percentage points today, if domestic inflation trends do not deviate significantly from the current forecast path?that is, if inflation remains at a higher level for the next few months and then gradually declines?it is desirable to gradually raise rates by 0.25 percentage points for the time being." The BOK expects inflation to peak in late Q3 or early Q4 and then decline moderately, so if this forecast holds, the possibility of a big step after August is low.

However, he added, "If inflation accelerates further due to domestic or external changes, or if the economic slowdown is greater than expected, the timing and magnitude of policy responses may also change," and "We will closely monitor the impact of rising exchange rates and capital outflow pressures in emerging markets and the resulting changes in international financial markets on our financial and foreign exchange markets."

Regarding market forecasts that the year-end base rate could rise to 2.75?3%, he said, "Given the high inflation trend, this is naturally reasonable," but added, "Because of high uncertainty, whether the rate will be below 2.75% or reach 3% depends on various factors such as major advanced countries' rates, oil prices, and the economy."

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