[The Editors' Verdict] Three Conditions for Stopping Interest Rate Hikes

Jae-Hyung Jeong, Economic and Financial Editor

Tomorrow (the 25th), the Bank of Korea is expected to raise the base interest rate by another 0.25 percentage points to 2.5%. This marks the fifth increase in eight months this year, totaling a 1.5 percentage point hike. While depositors may benefit, borrowers are feeling a heavy burden due to rapidly rising interest payments. Many forecasts suggest the rate could rise to 2.75% or even 3% by the end of the year.

When will the base interest rate hikes stop? When will the interest burden cease to increase further? Personally, I believe at least three conditions must be met.

First, the U.S. Federal Reserve (Fed) must stop raising its base interest rate. The U.S. base rate is currently 2.5%, higher than Korea’s 2.25%. It is already a foregone conclusion that the Fed will take another big step (a 0.5 percentage point hike) in September, which will widen the gap between the U.S. (3%) and Korea (2.5%). A larger interest rate gap between Korea and the U.S. could trigger concerns about capital outflows.

Although there have been precedents where the U.S. base rate was higher than Korea’s without significant capital outflows, the continuously widening interest rate gap cannot be ignored. It is necessary to prevent self-fulfilling expectations from forming in the market. If the Fed does not stop raising rates, the Bank of Korea will continue to raise its base rate as well.

Moreover, the recent base rate hikes by central banks worldwide have been driven by global inflation caused by the Russia-Ukraine war. The Fed halting its rate hikes can be seen as a signal that global inflation is being brought under control. Domestic inflation is also likely to slow down.

Even if global prices stabilize, domestic inflation may remain at a high level. What level of inflation do we consider appropriate, and at what point does the Bank of Korea believe it no longer needs to raise rates?

The era of low inflation, with consumer price inflation rates below 2%?in the 1% or 0% range?lasted from 2013 to 2020. During this period, abnormal quantitative easing continued for a long time due to the global financial crisis and the European debt crisis, and negative interest rates even appeared in Europe. This 'exceptional low inflation era' cannot be compared to the current situation, nor can it be compared to the 'pre-1997 foreign exchange crisis' period, which was a chronic capital shortage state with high interest rates and high inflation, where capital demand far exceeded supply.

Roughly speaking, the early to mid-2000s, when our economy began to take its current shape, can be considered a relatively normal '3% inflation era.' Therefore, the consumer price inflation rate should fall below 4% or show signs of doing so.

Another variable to consider is the economy. While stabilizing prices is the Bank of Korea’s primary responsibility, it cannot keep raising rates indefinitely if growth slows significantly. In tomorrow’s 'August Economic Outlook,' the Bank of Korea is expected to revise this year’s growth forecast downward from 2.7% in May to about 2.5%. The growth forecast for next year may also be slightly lowered from May’s 2.4%. Growth remains important in Korea, and many growth advocates prioritize the economy over inflation. This level of adjustment is still acceptable. However, if next year’s growth forecast falls below the 2% mark, the Bank of Korea will lose the momentum to continue raising rates.

There is still a long way to go. The Fed shows no signs of stopping its rate hikes. Although consumer price inflation is expected to peak in September or October, it will still take time to fall below 4%. Economic agents will likely have to consider additional rate hikes as a given for the time being.

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