Powell Signals Era of 5% Base Rate... Will Bank of Korea Continue 'Big Step'?

Unprecedented 4 Consecutive Giant Steps by US Fed
Powell Confirms 'Hawkish' Stance While Mentioning December Slowdown
"Too Early to Talk Rate Cuts... Final Rate Will Be Higher"
Bank of Korea at Big Step Crossroads... Balancing US-Korea Rate Gap and Growth Concerns

Jerome Powell, Chairman of the U.S. Federal Reserve (Fed) [Photo by Reuters]

The U.S. Federal Reserve (Fed) has implemented an unprecedented four consecutive 'giant steps' (0.75 percentage point increases in the benchmark interest rate), drawing attention to the future monetary policy moves of the Bank of Korea (BOK) as Fed Chair Jerome Powell delivered more hawkish-than-expected remarks. Although the U.S. officially signaled a slowdown in rate hikes in December, it firmly stated that "discussions on rate cuts are premature," leading to expectations that the BOK will face deepening concerns over a potential 'big step' (0.50 percentage point rate hike).

The U.S. central bank, the Fed, announced on the 2nd (local time) after the Federal Open Market Committee (FOMC) regular meeting that it would raise the benchmark interest rate by 0.75 percentage points. As a result, the U.S. benchmark rate rose from 3.00?3.25% to 3.75?4.00%, reaching the highest level in 15 years. This Fed decision widened the interest rate gap between South Korea and the U.S. to a maximum of 1 percentage point. As the interest rate inversion between Korea and the U.S. continues, concerns are growing over increased domestic capital outflows and upward pressure on the won-dollar exchange rate.

Since the Fed's 0.75 percentage point hike was anticipated, the market focused more on Chair Powell's remarks than the size of the rate increase. After the FOMC meeting, Powell mentioned the possibility of slowing the pace of rate hikes as early as December but said, considering various economic indicators, "the terminal rate will be higher than previously expected." He particularly emphasized that "it is very premature to think about or mention pausing rate hikes," reaffirming that high rates will persist for a considerable period.

Powell's more hawkish-than-expected comments have led to analyses suggesting an increased likelihood of a big step by the BOK. Initially, many in the market believed that the BOK might slow its tightening pace due to economic growth slowdown and liquidity tightening triggered by the 'Legoland incident,' but considering the interest rate gap between Korea and the U.S., this seems difficult. Powell hinted that the terminal rate might exceed the 4.6% projected in the September dot plot and approach 5%. If the BOK slows down with a 'baby step' (0.25 percentage point hike), the interest rate gap is bound to widen further.

Bank of Korea Governor Lee Chang-yong is explaining the base interest rate hike at a press briefing held at the Bank of Korea in Jung-gu, Seoul, on the 12th of last month.
Photo by Joint Press Corps

The domestic consumer price inflation rate remaining in the high 5% range for three consecutive months is also a burden. Last month, the consumer price index rose by 5.7%, after peaking at 6.3% in July, dropping to 5.7% in August and 5.6% in September, then rebounding again. The BOK expects inflation to continue in the 5% range until the first quarter of next year, with personal service prices rising in the 6% range. If the BOK prematurely raises expectations for slowing rate hikes, it could exacerbate inflation and increase upward pressure on the won-dollar exchange rate, which has risen to the 1,440 won level, accelerating import price increases and capital outflows.

However, political and market pressures to restrain rate hikes are expected to act as a burden. On the 1st, Yoon Chang-hyun, a member of the People Power Party, said at the National Assembly's Finance and Economy Committee full meeting that the rate hikes were "torturous," suggesting that the Financial Services Commission vice chairman, who has the right to speak at the Monetary Policy Committee, should attend the committee to convey opinions considering the overall financial market situation. This indirectly reveals discomfort with the BOK's big step and is interpreted as pressure to slow the pace of rate hikes.

Recently, as economic growth has slowed and liquidity tightening in the bond market has intensified, differences of opinion over the tightening stance have reportedly widened within the Monetary Policy Committee. Reviewing the minutes of the October BOK Monetary Policy Committee meeting recently released, most members advocated for a big step citing high inflation and won depreciation, but members Joo Sang-young and Shin Sung-hwan expressed that excessive rate hikes could sharply increase the risk of economic downturn and suggested a baby step would be appropriate.

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