The Bank of Korea Focuses on 'Economic Recession'... Growth Rate Forecast Lowered to 1.6% (Comprehensive)

Base Interest Rate Held at 3.5%
Fatigue from Consecutive Rate Hikes Accumulates
Growth Rate Lowered by 0.1%P This Year
Increased Uncertainty in Korean Economy
Lee Chang-yong "Assessing Need for Additional Hikes"

Lee Chang-yong, Governor of the Bank of Korea, is striking the gavel at the regular Monetary Policy Committee meeting held at the Bank of Korea in Jung-gu, Seoul on the 23rd. Photo by Joint Press Corps

[Asia Economy reporters Seo So-jeong and Moon Je-won] The Bank of Korea (BOK) froze its benchmark interest rate at 3.5% on the 23rd during the Monetary Policy Committee meeting, halting the rate hike streak that had continued for the past year and a half. The BOK’s decision to pause the rate hikes this time is interpreted as a shift in focus toward 'economic recession' amid ongoing unstable economic conditions. On the same day, the BOK lowered its economic growth forecast for this year by 0.1 percentage points from the November forecast last year (1.7%).

The BOK’s Monetary Policy Committee held a monetary policy direction meeting on the 23rd and decided to keep the benchmark interest rate unchanged. The committee had previously raised the rate consecutively seven times for the first time in history during meetings in April, May, July, August, October, and November last year, as well as last month. However, by freezing the rate this month, it avoided an eighth consecutive hike.

The BOK’s decision to hold the rate steady despite persistent high inflation reflects the growing need to assess the effects of the accumulated fatigue from successive rate hikes. The government’s recent official acknowledgment of economic slowdown and rising concerns over a hard landing in the real estate market also contributed to the increased burden of further hikes. Kang Min-joo, an economist at ING Bank, explained, "Due to last year’s rapid rate hikes, financial market conditions have tightened, and with household debt deleveraging underway, additional rate hikes could prolong the economic recession. The possibility of further tightening leading to a sharp economic downturn likely influenced the committee’s decision to freeze rates this month."

◆This Year’s Growth Rate Lowered by 0.1%P to 1.6% = In the revised economic outlook released on the day, the BOK lowered this year’s growth forecast to 1.6%. The BOK’s growth forecast is lower than most institutions such as credit rating agency Fitch (1.9%), the Organisation for Economic Co-operation and Development (OECD, 1.8%), Korea Development Institute (KDI, 1.8%), and the International Monetary Fund (IMF, 1.7%), equal to the government’s forecast (1.6%), and higher than the Korea Economic Research Institute’s (1.5%). The BOK also lowered its consumer price inflation forecast for this year by 0.1 percentage points from 3.6% to 3.5%. It expects growth to rise to 2.4% next year, with inflation stabilizing at 2.6%.

On the day, BOK Governor Lee Chang-yong said, "The Monetary Policy Committee will continue to monitor growth while managing monetary policy to ensure inflation stabilizes at the target level over the medium term, paying close attention to financial stability." He emphasized, "Although domestic economic growth is expected to slow, inflation is projected to remain above the target level with high upward momentum, and policy uncertainties remain high. Therefore, it is necessary to maintain a tightening stance for a considerable period while assessing the need for further hikes with a focus on price stability."

As the BOK repeatedly lowers its economic growth forecast for this year, market attention is focused on the implications for future monetary policy. The decision to freeze the benchmark rate at 3.5% was largely influenced by growing concerns over domestic and global economic recessions. Global semiconductor industry downturns have led to continued declines in South Korea’s exports, and high inflation and high interest rates have weakened consumer recovery, increasing market worries about further rate hikes. With export slumps continuing, South Korea’s real GDP growth turned negative (-0.4%) in the fourth quarter of last year, and forecasts predict continued contraction in the first quarter of this year. The prolonged Russia-Ukraine conflict and interest rate hikes by major countries have expanded the slowdown in exports, noticeably weakening growth momentum.

Lee Jae-hyung, a researcher at Yuanta Securities, analyzed, "With stabilized market liquidity conditions, slower money supply growth, and declining household debt, the need to manage market liquidity has weakened. Although there is significant uncertainty in major countries’ monetary policies, concerns over credit tightening related to real estate and public utility fee hikes have been factored into monetary policy due to the policy burden on household interest expenses."

However, the recent possibility that the U.S. Federal Reserve (Fed) may maintain policy rates at higher levels for longer than expected, along with hawkish remarks from key officials, has raised the ceiling for the U.S. terminal rate as a variable. While the BOK’s rate freeze maintained the interest rate gap with the U.S. at 1.25 percentage points (Korea 3.50% vs. U.S. 4.50?4.75%), if the Fed raises rates by at least a baby step (0.25 percentage points) next month, the gap will widen again to a record 1.50 percentage points. A further widening of the Korea-U.S. interest rate gap could increase concerns over capital outflows and cause the won-dollar exchange rate to surge again.

Lee Chang-yong, Governor of the Bank of Korea, is presiding over the regular Monetary Policy Committee meeting held on the 23rd at the Bank of Korea in Jung-gu, Seoul. Photo by Joint Press Corps

◆Possibility of Upward Adjustment to Terminal Rate Emerges = Although the BOK froze the benchmark rate as expected this month, market attention is focused on the terminal rate and its duration. Opinions are divided between those who believe the rate hike cycle is nearing its end with this freeze and those who see the possibility of further hikes depending on the rate hike paths of the U.S. and other major countries.

Kim Sung-soo, an analyst at Hanwha Investment & Securities, said, "Most Fed officials advocating aggressive rate hikes do not have voting rights this year, while many voting members are cautious about future monetary policy operations. If the interest rate gap between Korea and abroad widens beyond 2.0 percentage points, the BOK may consider additional hikes. However, past cases have shown that the interest rate gap does not have an absolute impact on exchange rates or foreign capital flows, so 3.5% is likely to be the terminal rate."

On the other hand, Joo Won, head of economic research at Hyundai Research Institute, said, "Domestic inflation remains high at around 5%, and with the Fed expected to raise rates twice more in March and May, the BOK could also raise rates by an additional 0.25 percentage points." He predicted, "In the fourth quarter of this year, when the need to stimulate the economy increases, the BOK will begin to cut rates to ease the high interest burden on households and businesses."

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