"If the base interest rate rises by 0.25 percentage points, private consumption decreases by up to 0.15%"

Bank of Korea Reviews Impact of Interest Rate Hikes on Domestic Demand by Sector Report

[Asia Economy Reporter Seo So-jeong] It has been found that when the base interest rate rises by 0.25 percentage points, private consumption decreases by up to 0.15%. Accordingly, if interest rate hikes continue, the slowdown in private consumption is expected to be a major factor dragging down the growth rate.

On the 27th, the Bank of Korea stated in its report titled "Review of the Impact of Interest Rate Increases on Domestic Demand Sectors" that "the effects of the base interest rate hikes that have continued since August last year are expected to become visible with a time lag."

According to the Bank of Korea, the interest rate elasticity (the extent to which consumption and investment shrink when the base interest rate rises by 0.25 percentage points) derived from various macroeconomic models showed that in the first year of the hike, private consumption decreased by 0.04?0.15%, facility investment by 0.07?0.15%, and construction investment by 0.07?0.13%. Although the differences among sectors were not large, considering their shares in GDP, the impact of consumption slowdown is expected to be relatively greater than that of investment.

Examining the impact of interest rate increases by sector, private consumption was mainly slowed down through declines in asset prices and deterioration of interest income and expenses. Due to the global rise in interest rates, stock prices have fallen significantly, and expectations of housing price declines are gradually increasing, raising the likelihood of consumption constraints through the asset price channel.

Looking at past data, after the base interest rate rose by 0.25 percentage points, by the sixth quarter, the decrease in private consumption due to falling stock and housing prices reached up to 0.12%. In particular, stock prices had a greater impact on private consumption than housing prices. Additionally, during periods of rising interest rates, loan interest rates rose faster than deposit rates, worsening household interest income and expenses, which negatively affected consumption capacity. By type, durable goods consumption was more sensitive to interest rate changes than services.

In the facility investment sector, interest rate hikes increase financing costs, slowing facility investment; however, downward pressure on the exchange rate is expected to ease cost burdens from capital goods imports, partially mitigating the slowdown effect. Furthermore, facility investment in non-manufacturing and non-IT manufacturing sectors responded more sensitively to interest rates than IT manufacturing.

In the construction investment sector, construction investment is mainly constrained by increased financing costs for construction demanders, with construction demand outside the metropolitan area being more sensitive to interest rates than in the metropolitan area. Recently, with rising construction material prices worsening construction companies’ profitability, if interest burdens expand due to interest rate hikes, there is a possibility that financing conditions for some construction companies with weak financial soundness may deteriorate.

Park Kyung-hoon, Deputy Director of the Trend Analysis Team at the Bank of Korea’s Research Department, said, "The impact of interest rate hikes is likely to be significant in vulnerable sectors such as low-income, marginal, and over-indebted households and companies," adding, "However, the benefits of interest rate hikes, such as easing inflation, should also be considered alongside demand slowdown."

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