After a Breather Amid US Inflation Easing, Bank of Korea to Take Baby Steps in January Next Year?

Fed Board Member Emphasizes Need to Adjust Pace

[Asia Economy Reporter Seo So-jung] The U.S. consumer price inflation rate fell short of market expectations, increasing the likelihood that the U.S. Federal Reserve (Fed) will slow the pace of monetary tightening. This development is expected to give the Bank of Korea (BOK), which will decide its monetary policy next year, more room to maneuver. If the Fed slows its tightening pace due to the possibility of inflation easing, the BOK will also have justification to adjust its own tightening speed. Since August last year through last month, the benchmark interest rate has risen by 2.75 percentage points, accumulating fatigue over rate hikes. Moreover, the liquidity crunch triggered by the Legoland incident has not been fully resolved despite the government's large-scale liquidity supply measures. The soaring interest burden from household debt reaching 1,870 trillion won and the rapidly cooling real estate market are acting as factors weighing against further rate hikes.

◆ BOK gains more room for monetary policy maneuvering = On the 14th, the BOK expressed relief over the slowdown in the U.S. Consumer Price Index (CPI) announced overnight and is closely monitoring the Federal Open Market Committee (FOMC) results to be released early on the 15th. The U.S. CPI inflation rate showed the lowest level since December last year, reinforcing views that inflation has peaked and raising expectations for a slowdown in the Fed's tightening pace. Accordingly, with the Fed expected to take a big step (0.50 percentage point hike) rather than a giant step (0.75 percentage point hike) at the FOMC, there is growing speculation that the BOK will also take a baby step (0.25 percentage point hike) rather than a big step at the Monetary Policy Board meeting in January next year. There is also a possibility of keeping the benchmark rate unchanged.

According to the minutes of last month's Monetary Policy Board meeting released the day before, a majority of board members expressed the view that while the policy of raising the benchmark interest rate should continue for the time being, the magnitude and pace of hikes need to be adjusted. Last month, the board unanimously agreed on a 0.25 percentage point rate hike, noting that although inflationary pressures were somewhat easing, expected inflation and the inflation rate remained at high levels. The consensus was that maintaining a tightening stance in monetary policy to respond to the underlying inflationary trend was desirable.

However, a changed atmosphere was sensed as many board members raised the need to ease the pace of tightening. One board member emphasized, "As Korea is an open economy with the possibility of capital outflows depending on domestic and external conditions, and considering that if tightening capacity is exhausted due to domestic financial stability issues, various side effects may occur, it is necessary to carefully decide the pace of tightening in the future while reviewing the transmission effects of monetary policy and observing the development of domestic and external uncertainty factors." Another member also stated, "Additional considerations regarding inflation when deciding the benchmark rate in the future include transmission lags, the speed of disinflation, and next year's economy," adding, "The impact of the rate hikes since August last year on consumer prices is expected to become more pronounced next year than this year." The member further judged, "After confirming a fundamental change in the inflation rate, monetary policy should be operated by placing greater weight on the real economy and financial stability sectors than at present, taking into account the speed of disinflation and economic conditions."

Furthermore, one member expressed the opinion that greater caution is needed regarding future rate hikes. This member diagnosed, "It has been 15 months since the benchmark rate was raised, and its effects are becoming more pronounced, especially in the real estate and financial markets," noting, "There is a tendency for funds to flock to safe assets such as time deposits, while the corporate bond and short-term money markets are showing signs of instability." The member emphasized, "Although this may be a temporary and localized instability, the possibility of spread cannot be ruled out, so caution is necessary when raising the policy rate."

[Image source=Yonhap News]

◆ Market attention turns to U.S. FOMC = With the slowdown in U.S. consumer price inflation overcoming a hurdle, market attention is now shifting to the U.S. FOMC. The key focus of this FOMC is the terminal interest rate level. Previously, the Wall Street Journal (WSJ) predicted that if the November CPI was higher than expected, the Fed would take big steps not only this month but also at the next meeting in February. However, with the confirmed slowdown in consumer prices, the market is now discussing the possibility that the Fed's rate hikes next year may be reduced to 0.25 percentage points.

Professor Ha Jun-kyung of Hanyang University's Department of Economics said, "If the U.S. continues to take consecutive big steps until February next year, the interest rate gap between Korea and the U.S. will widen further, increasing the likelihood of capital outflows and depreciation of the Korean won. However, as U.S. inflation shows signs of easing, the Fed is expected to slow its monetary tightening pace," adding, "If the Fed slows down, the BOK is also likely to slow its pace."

However, even if the pace of U.S. rate hikes slows somewhat, Korea cannot be fully reassured. If the Fed takes a big step as expected on the 15th, the interest rate gap between Korea (3.25%) and the U.S. (4.25?4.50%) will widen to 1.25 percentage points. This 1.25 percentage point gap is close to the largest historical Korea-U.S. rate inversion of 1.50 percentage points, raising concerns about intensified foreign capital outflows ahead of next month's Monetary Policy Board meeting. Oh Chang-seop, a researcher at Hyundai Motor Securities, said, "There is still a possibility that the terminal rate level during this Fed rate hike cycle will be revised upward or that the duration of hikes will be extended at this FOMC," adding, "Depending on remarks by Fed Chair Jerome Powell and others, volatility in domestic foreign exchange and financial markets may increase."

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