"Cycle is over"... Momentum Builds for 'End of Benchmark Interest Rate Hike Theory' (Comprehensive)

Bank of Korea Holds Monetary Policy Direction Meeting
Decides to Keep Rates Steady for Two Consecutive Times

[Image source=Yonhap News]

On the 11th, the Bank of Korea's Monetary Policy Committee decided to keep the base interest rate steady at 3.5% per annum. The committee halted the rate hike streak that had lasted for one and a half years since February and decided to maintain the rate for two consecutive times this month, which has strengthened the 'end of rate hike' theory, signaling the conclusion of the Bank of Korea's rate hike cycle.

At the monetary policy direction meeting held that day, the Bank of Korea's Monetary Policy Committee decided to keep the base rate at 3.50% per annum. Previously, the committee had continuously raised rates for 18 months since August 2021, increasing the base rate by 3.00 percentage points. In February of this year, amid ongoing economic uncertainties, the rate was held steady to 'catch a breath,' and with the consecutive freeze this month, market views have been reinforced that the tightening cycle is nearing its end. With the Bank of Korea maintaining the base rate, the interest rate gap with the United States (4.75~5.00%) remains at an upper limit of 1.5 percentage points.

The main reason for the Bank of Korea's decision to hold rates this month is the recent slowdown in consumer price inflation, which has gradually reduced inflationary pressures. The consumer price inflation rate in March fell to 4.2%, the lowest in a year and in the low 4% range, showing signs of easing inflation and weakening the need for further tightening. Park Seok-gil, an economist at JP Morgan, said, "Inflation stabilization is expected to gradually take hold in the second half of the year," adding, "Given the increased uncertainty in international financial markets, it appears the Bank of Korea decided to hold rates to wait for the stabilizing effects of previous rate hikes."

Bank of Korea Governor Lee Chang-yong forecasted, "This year's growth rate will slightly underperform the February forecast (1.6%), and the consumer price inflation rate will drop to the 3% range after the second quarter, aligning with the February forecast of 3.5% for the year." Governor Lee emphasized, "We will operate monetary policy with attention to financial stability while monitoring growth trends and ensuring inflation stabilizes at the target level over the medium term."

Decision to 'Hold' Amid Slowing Inflation and Domestic Economic Slowdown

In particular, the visible slowdown in the domestic economy, including exports and domestic demand, is another reason for the rate freeze. With continued export sluggishness, South Korea's real GDP growth rate recorded a negative -0.4% in the fourth quarter of last year, and it remains uncertain whether the economy has escaped contraction in the first quarter of this year. The current account deficit reached a record high of $4.52 billion in January, and deficits continued in February, prolonging the downturn.

Another background for the freeze is the easing of expectations for further rate hikes by the U.S. Federal Reserve (Fed) amid global banking risks such as the Silicon Valley Bank (SVB) and Credit Suisse (CS) incidents. Kang Seung-won, a researcher at NH Investment & Securities, said, "The option for accelerated Fed tightening, which was a major reason for additional hikes, has effectively disappeared," adding, "With inflation falling below the Bank of Korea's forecast and a shift in focus to the economy, the Bank of Korea's rate hike cycle has already ended."

With the Monetary Policy Committee's decision to hold rates this month, the market is accepting the end of the rate hike cycle as a given. Joo Won, head of economic research at Hyundai Research Institute, said, "The rate hike cycle has effectively ended due to easing inflation and recession concerns," and predicted, "The Bank of Korea may start cutting rates in the second half of this year ahead of the U.S. Fed." On the other hand, Cho Young-moo, a research fellow at LG Economic Research Institute, said, "The U.S. economy will enter a recession by mid-year, and U.S. rate hikes will end in the first half," adding, "Given the historically wide interest rate gap between Korea and the U.S., it will be difficult for Korea to switch to rate cuts before the U.S. Fed. The Bank of Korea is unlikely to lower the base rate until the end of the year."

Record High Korea-U.S. Interest Rate Gap and Rising International Oil Prices as Variables

[Image source=Yonhap News]

However, the possibility of further rate hikes has not been completely eliminated. With the Bank of Korea holding rates this month, the interest rate gap between Korea and the U.S. remains at 1.50 percentage points. If the U.S. Federal Reserve raises the base rate by 0.25 percentage points at the May Federal Open Market Committee (FOMC) meeting, the gap with the U.S. (5.00~5.25%) will widen to an upper limit of 1.75 percentage points. This would surpass the previous maximum gap of 1.5 percentage points recorded from May to October 2000, setting a new record for the largest interest rate differential, which could become a burden. A wider gap with the U.S. could increase pressure on foreign investors to withdraw funds from the Korean won, which is not a key currency, causing exchange rate volatility.

Another variable is the recent sharp rise in international oil prices following the production cut announcement by the Organization of the Petroleum Exporting Countries (OPEC) and the OPEC Plus (+) group, which includes major non-OPEC oil producers such as Russia. If oil prices rise again, airfares and transportation costs will surge, and energy prices such as electricity will also fluctuate, negatively impacting inflation. According to the New York Mercantile Exchange, the price of Dubai crude, one of the world's three major oil types, rose from $74.1 per barrel on the closing day of last month (24th) to $84.28 per barrel the day before, and West Texas Intermediate (WTI) also increased from $66.74 on the 17th of last month to around $80 recently.

Medium and small oil-producing countries such as Iran, Norway, Kazakhstan, and Nigeria are increasing oil production regardless of the production cut agreement, keeping international oil prices in the $80 per barrel range. However, this is considered a temporary factor, and there are many concerns that oil prices could rise further in the mid to long term. Kang Sam-mo, a professor of economics at Dongguk University, explained, "The government is shifting its focus more toward economic growth than inflation, and the Bank of Korea cannot completely ignore the government's concerns, including those of the Ministry of Economy and Finance," adding, "If oil prices rise again and inflation does not show a downward stabilization trend, the Bank of Korea may resume rate hikes."

In fact, the Bank of Korea's stance is that it can end tightening on the premise that the consumer price inflation rate will fall to the low 3% range by the end of this year and move toward the 2% target, which is based on the expectation that international oil prices will stabilize in the $70~80 per barrel range. If oil prices approach $100 per barrel as they did last year, the Bank of Korea's monetary policy will inevitably return to tightening. The government is also closely monitoring the impact of recent production cut decisions by oil-producing countries on oil prices and inflation. President Yoon Suk-yeol urged Prime Minister Han Duck-soo the day before to "closely manage the energy supply situation and make thorough preparations for vulnerable groups," which is interpreted as a directive to respond so that rising oil prices do not burden the economy.

Concerns Over 'Core Inflation' That Does Not Easily Fall

Although the overall inflation trend is slowing, the 'broad and sticky' inflationary phenomenon persists. According to Statistics Korea, among 458 consumer price items last month, 395 items (a whopping 86.2%) saw price increases compared to a year ago. While the overall inflation rate is slowing, the number of items with higher prices has actually increased.

Core inflation, which shows the inflation trend, is also not falling easily. Excluding petroleum products and agricultural products, core inflation rose 4.8% year-on-year last month, exceeding the consumer price inflation rate (4.2%). Core inflation excluding food and energy, which the Bank of Korea uses as a key indicator, remained at 4.0%, the same as the previous month. Additionally, increases in public utility fees such as electricity and gas are cited as major variables. Although the second-quarter fee hikes were postponed, considering the deteriorating management of Korea Electric Power Corporation and Korea Gas Corporation, public utility fee increases seem inevitable.

However, since the economic recession is becoming more pronounced, there are opinions that inflation is unlikely to surge again despite rising oil prices and public utility fees. Kim Young-ik, a professor at Sogang University Graduate School of Economics, said, "Even if oil-producing countries cut production, the U.S. is likely to enter negative growth centered on consumption from the second quarter, making it difficult for oil prices to rise significantly," adding, "It is appropriate to see that the rate hike phase is ending for both the U.S. and Korea."

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