[Base Rate 3%] Will the Bank of Korea Take a Big Step Again in November?... Mixed Forecasts

At Next Month's FOMC, If a Giant Step Occurs
KOR-US Interest Rate Gap Widens Again to 1%P
Tight Debate Over 0.25% Point vs 0.5%

Lee Chang-yong, Governor of the Bank of Korea, is presiding over the regular Monetary Policy Committee meeting held on the 12th at the Bank of Korea in Jung-gu, Seoul. Photo by Joint Press Corps

[Asia Economy Reporter Seo So-jeong] Lee Chang-yong, Governor of the Bank of Korea, tightened the reins on rate hikes by implementing a second big step, pushing interest rates into the 3% range. This move comes as the U.S. Federal Reserve (Fed) continues its high-intensity tightening, and domestic inflation is expected to remain in the 5% range until early next year, raising concerns about the ‘entrenchment of high inflation,’ making inflation control the top priority. The won-dollar exchange rate, currently approaching 1,440 won, also adds pressure to prices, leading to a plan to maintain the rate hike stance for the time being.

The reason the Bank of Korea reversed its previous ‘forward guidance’ of gradually raising the base rate by 0.25 percentage points until the end of the year and took a second big step on the 12th is due to strong inflationary pressures. The inflation rate, which was 3.6% in January this year, showed a steep rise to 4.1% in March and 5.4% in May, then surged to 6.0% and 6.3% in June and July respectively, marking the highest level since November 1998 (6.8%) during the foreign exchange crisis. Although the rate of increase slowed to 5.7% in August and 5.6% in September, it remains at a high level.

Although international oil prices have stabilized somewhat, slowing the inflation trend, unexpected variables remain. Recently, geopolitical tensions surrounding Ukraine and Russia have intensified, strengthening the U.S. dollar, while the Organization of the Petroleum Exporting Countries Plus (OPEC+)’s decision to cut production has increased upward pressure on international oil prices. Additionally, the expectation that the Fed will accelerate tightening is another factor that prevents easing the reins on rate hikes.

With the U.S. September employment report released late last week showing solid performance, expectations for the Fed to slow its tightening have diminished. The market anticipates that the U.S. September Consumer Price Index (CPI), to be announced on the 13th, will reach 8.1%. The won-dollar exchange rate, fluctuating around the 1,430 won level recently, is also a source of instability.

The inversion of interest rates between Korea and the U.S. is another reason supporting the Monetary Policy Committee’s decision to raise rates. With the Bank of Korea taking a big step this month, the upper bound of U.S. rates is 0.25 percentage points higher than Korea’s. If the Federal Open Market Committee (FOMC) holds a regular meeting in early November and consecutively takes a giant step (raising the base rate by 0.75 percentage points), the upper bound of U.S. rates will rise to 4.00%, which is 1 percentage point higher than Korea’s 3.00%. Even if the Bank of Korea raises rates by another 0.25 percentage points at the end of November, if the Fed takes at least a big step in December, the year-end rate is expected to reach 4.5%, potentially widening the Korea-U.S. interest rate gap to 1.25 percentage points. For the won, which is not a key currency like the dollar, an inverted or narrowed interest rate gap raises concerns about foreign investor capital outflows.

Now, market attention is turning to the November Monetary Policy Committee meeting. Experts generally agree that the rate hike stance should continue next month, but opinions differ on the magnitude of the increase. Professor Sung Tae-yoon of Yonsei University’s Department of Economics said, “Given that inflation has not easily subsided, the focus of monetary policy should remain on price stability for the time being.” On the other hand, Joo Won, Director of Hyundai Research Institute, predicted, “Although the exchange rate has risen significantly, inflation seems to be somewhat stabilizing, concerns about an economic recession are spreading, and the burden of household debt due to rapid rate hikes is increasing, making it difficult for the Bank of Korea to take a third big step.”

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