[BOK Focus] Bank of Korea on Alert for US Fed... Will the Final Interest Rate Rise?

FOMC Member: "Many Factors to Consider in Monetary Policy"

[Asia Economy Reporter Seo So-jeong] As the U.S. Federal Reserve (Fed) is expected to take a big step (a 0.5 percentage point increase in the benchmark interest rate) in mid-this month and continue with big steps next year, the Bank of Korea, which decides monetary policy, is on high alert. With the possibility of U.S. monetary tightening being 'stronger and longer' than expected increasing, there is a forecast that the market's expectations for Korea's terminal interest rate may also rise.

According to the financial investment industry on the 7th, following the robust economic indicators such as the U.S. November employment report, concerns about further Fed rate hikes have been raised, drawing attention to the potential impact on domestic monetary policy. The Wall Street Journal (WSJ) reported on the 5th (local time) that the Fed may raise the terminal rate level above 5% and consider consecutive big steps at the next meeting in February next year. It is expected that the Fed will raise its forecast for next year's benchmark interest rate from the previous 4.5?5% to 4.75?5.25% in the dot plot (a chart showing FOMC members' interest rate projections) to be released after this month's Federal Open Market Committee (FOMC) meeting.

With a 0.5 percentage point rate hike at the FOMC regular meeting scheduled for the 13th?14th becoming a foregone conclusion, if the U.S. November Consumer Price Index (CPI) announced on the 13th comes out high, the possibility of consecutive big steps in February next year increases, changing market sentiment. Initially, Fed Chair Jerome Powell's speech at the Brookings Institution on the 30th of last month (local time), where he said "the pace of rate hikes in December could be adjusted," raised expectations for a slowdown in tightening. However, recently, even if U.S. inflation slows, if the overheated labor market does not cool down, there is growing weight to the view that the Fed may act more hawkishly than expected, dampening the financial market.

Moreover, concerns about a recession due to continued tightening have emerged, with JPMorgan Chase CEO Jamie Dimon warning that inflation is "likely to derail the economy and cause a mild or severe recession," leading to weakened investor sentiment. As fears of tightening resurface, the KOSPI opened down 0.30% at 2,385.87, and the won-dollar exchange rate, which started at 1,322.0 won, up 3.2 won from the previous day's closing price, is also showing an upward trend.

[Image source=Yonhap News]

The Bank of Korea, which has just concluded this year's last Monetary Policy Committee (MPC) meeting and is preparing for the January MPC next year, is also closely monitoring the situation. Currently, Korea's benchmark interest rate stands at 3.25%. If the Bank of Korea raises the rate by 0.25 percentage points in January next year, and the U.S. Fed raises rates by 0.50 percentage points consecutively this month and in February, the interest rate gap between Korea and the U.S. could widen to a maximum of 1.5 percentage points. This would be the second time since May 2000 that the Korea-U.S. interest rate gap has reached 1.5 percentage points, potentially intensifying concerns about capital outflows.

Governor Lee Chang-yong stated at last month's MPC regarding the interest rate gap between Korea and the U.S., "We do not mechanically follow the Fed," adding, "If the interest rate gap with the U.S. widens significantly, we will assess how it affects the foreign exchange market and inflation before making a decision." He also mentioned about the terminal rate, "The MPC members' forecasts were centered around 3.50%, but since domestic factors may also change, we need to decide with more flexibility rather than focusing solely on the level." Given the ongoing high inflation in the 5% range, as well as domestic factors such as short-term money market tightening and real estate downturn, there is a need to respond flexibly in monetary policy decisions. In particular, with global investment banks forecasting that Korea's economic growth rate will sharply fall to the low 1% range next year due to the global recession impact, the Bank of Korea's dilemma of balancing inflation and growth is expected to deepen.

Regarding this, MPC member Shin Sung-hwan said, "At last month's MPC, opinions on the terminal rate varied widely from 3.25% to 3.75%, and there are differences in views among members on various issues," adding, "Recently, changes in the pace of Fed tightening have been detected, and since domestic financial stability conditions must also be closely observed, MPC members' opinions may change in the future."

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