Urgent Issues of Prices and Exchange Rates... Interest Rate Hike Trend May Continue Until Year-End (Comprehensive Report 2)

BoK Raises Rate by 0.25%P to 2.50%
Unanimous Decision by 7 MPC Members
Could Reach 3.00% by Year-End
Inflation Forecast at 5.2%, Highest in 24 Years
Growth Forecast Downgraded to 2.6%
Lee Chang-yong "No Consideration of Big Step"

Lee Chang-yong, Governor of the Bank of Korea, is presiding over the regular Monetary Policy Committee meeting held on the 25th at the Bank of Korea in Jung-gu, Seoul. / Photo by Joint Press Corps

[Asia Economy reporters Seo So-jeong and Moon Je-won] The Bank of Korea's Monetary Policy Committee raised the base interest rate by 0.25 percentage points to 2.50% per annum on the 25th. The Monetary Policy Committee had previously raised the base rate in meetings held in April, May, and July, and with this month's increase, it set a record for the first-ever four consecutive rate hikes.

The Bank of Korea also revised this year's consumer price inflation forecast to 5.2%, the highest since the implementation of the price stabilization target system in 1998, clearly signaling its intention to continue the rate hike trend. If additional rate hikes occur in the remaining Monetary Policy Committee meetings this year (October and November), the year-end base rate could rise to a maximum of 3.00%.

Next year's inflation forecast was also raised by 0.8 percentage points from 2.9% to 3.7%. However, with growing concerns over a global economic recession, the slowdown in the U.S. and Chinese economies, a bleak export outlook in the second half, and the combined effects of rising prices and interest rates potentially reducing consumption, the Bank of Korea is expected to face significant challenges in determining future monetary policy directions.

◆ Highest inflation rate in 24 years = The Bank of Korea's Monetary Policy Committee held a monetary policy decision meeting and unanimously raised the base interest rate from 2.25% to 2.50% per annum. This year, the base rate was increased by 0.25 percentage points each in January and April, by 0.50 percentage points in July, and by an additional 0.25 percentage points this time, returning to the 2.50% level last seen in August 2014.

Despite concerns about economic slowdown, the Bank of Korea took the unprecedented step of four consecutive rate hikes because controlling inflation is a more urgent priority. Although recent declines in international oil and grain prices have raised hopes that inflation has peaked, prices, which have risen to the 6% range, are not easily subdued. The expected inflation rate, which corresponds to the anticipated inflation over the next year, fell by 0.4 percentage points this month to 4.3% from the historic high of 4.7% in July, but still remains at a high level in the 4% range.

In its revised economic outlook, the Bank of Korea adjusted the consumer price inflation forecast from the current 4.5% up by 0.7 percentage points to 5.2%. If inflation exceeds 5%, it would be the highest in 24 years since 1998 (7.5%). The inflation forecast itself is the highest since the price stabilization target system was implemented in April 1998. Professor Lee In-sil of Sogang University Graduate School of Economics said, "Domestically, the high inflation situation is expected to continue into the second half of the year," adding, "Since the expected inflation rate remains high in the 4% range, the Bank of Korea should now prioritize inflation over economic slowdown in its monetary policy."

Bank of Korea Governor Lee Chang-yong said, "Although downside risks to the domestic and global economy have increased, high inflationary pressures and expected inflation continue," emphasizing, "It is necessary to maintain policy responses to prevent the entrenchment of high inflation." He predicted that the peak of consumer price inflation would come earlier than the initially expected September-October period. Governor Lee stated, "International oil prices have sharply declined over the past two months, so the consumer price inflation rate in August is expected to be lower than in July," and forecasted, "The high consumer price inflation in the 5-6% range is likely to continue until early next year."

◆ Widening interest rate gap between Korea and the U.S. again = The reversal of base interest rates between Korea and the U.S. is also a factor behind the Monetary Policy Committee's rate hike. The U.S. Federal Reserve (Fed) raised its policy rate by a giant step (0.75 percentage points) consecutively at last month's Federal Open Market Committee (FOMC) meeting, pushing the upper bound of the U.S. policy rate to 2.50%, higher than Korea's 2.25%. With this month's 0.25 percentage point hike by the Bank of Korea, the upper bounds are now equal, but if the U.S. raises rates again next month by a big step (0.50 percentage points) or a giant step, the interest rate gap between Korea and the U.S. will inevitably widen further. Jo Young-moo, a research fellow at LG Economic Research Institute, expressed concern, saying, "For the Korean won, which is not a key currency like the dollar, if the interest rate gap reverses or narrows, foreign investment funds may flow out, and the resulting sharp rise in the won-dollar exchange rate could fuel inflation."

In particular, the recent sharp rise in the won-dollar exchange rate has added inflationary pressure, providing a pretext for interest rate hikes. To curb the relentless rise in the exchange rate, foreign exchange authorities intervened verbally for the first time in two months, but it was insufficient to stop the upward trend. On the 23rd, the won-dollar exchange rate surged to 1,346.6 won intraday, setting a new yearly high.

◆ Divergent views on future big step hikes = Experts agreed on the necessity of rate hikes by the Monetary Policy Committee in the second half of the year but showed differing opinions on the big step approach of raising the base rate by 0.5 percentage points at once. Professor Kang Sung-jin of Korea University’s Department of Economics said, "Although the exchange rate has risen significantly, inflation seems to be slightly slowing, so it is not easy for the Bank of Korea to choose a big step." On the other hand, Cho Kyung-yeop, head of economic research at the Korea Economic Research Institute, said, "Considering inflation and exchange rate issues, it is necessary to somewhat align with the U.S. base rate to reduce medium- to long-term burdens, so big steps should also be considered."

Regarding the possibility of a big step, Governor Lee said, "It can be considered in principle if a shock occurs, but it is not being considered at this time." The Bank of Korea plans to maintain a gradual rate hike policy of 0.25 percentage points for the time being. Governor Lee explained, "Since the current economic situation is not significantly different from the domestic inflation and growth trends expected in July, we judged that gradual increases of 0.25 percentage points, as presented at last month's monetary policy meeting, are appropriate." He also evaluated the market expectation that the year-end base rate will rise to 2.75?3.00% as "reasonable," consistent with last month.

On this day, the Bank of Korea lowered its real gross domestic product (GDP) growth forecast for this year from 2.7% to the 2.6% range. The growth forecast for next year was also lowered by 0.3 percentage points from 2.4% to 2.1%. This is due to the possibility of a slowdown in export growth amid economic downturns in the U.S., China, and other countries, as well as reduced consumption caused by inflation and interest burdens. Professor Kang said, "Currently, exports are increasing, but imports are increasing even more, causing an expansionary deficit, so growth is expected to continue declining until oil prices stabilize completely," adding, "This is a global phenomenon, so difficult conditions will persist this year."

Governor Lee said, "The reason for lowering next year's growth forecast to 2.1% is partly due to internal factors but also because overseas factors are worsening," adding, "It is unreasonable to maintain a high growth rate only for Korea when global growth is declining, and achieving 2.1% would be a relatively good result." He continued, "Since this is higher than the potential growth rate, it is difficult to call it stagflation," and added, "Compared to global conditions, we are doing well, and it is important to maintain this trend."

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