[Q&A] Lee Ju-yeol "Decision to Raise Interest Rates Within the Year Considering Economic Developments"

Bank of Korea sharply raises annual growth forecast from 3.0% to 4.0%
"Not matching Fed rate hikes 1:1"... Korean economic conditions are key
Future base rate hikes unrelated to governor's term or presidential election

[Asia Economy Reporter Jang Sehee] Lee Ju-yeol, Governor of the Bank of Korea, said on the 27th, "Whether to raise interest rates within this year depends on the development of the economic situation."

Governor Lee made this remark at a press conference held immediately after the Monetary Policy Committee meeting at the Bank of Korea headquarters in Seoul. He said, "It is difficult to specify the timing, but the important task is how to orderly adjust monetary policy going forward." The Bank of Korea lowered the base interest rate from 1.25% to 0.75% in March last year and further to a record low of 0.5% in May of the same year, maintaining the same level for eight consecutive times until this month.

The Bank of Korea forecasted that the Korean economy will grow by 4.0% this year. In February, the Bank of Korea maintained the growth forecast at 3.0%, so this is a significant upward revision. The Bank of Korea also raised the growth forecast by 1.0 percentage point to 4.6% in December 2009, during the aftermath of the global financial crisis.

However, the Monetary Policy Committee decided to keep the base interest rate at the current 0.50% per annum. Although the domestic economy is showing signs of recovery in exports and investment, factors such as ▲ the continuation of social distancing measures causing varying recovery speeds across industries ▲ low vaccination rates ▲ COVID-19 variants could act as constraints on growth.

The following is a Q&A with Governor Lee.

▲ What is the background for the interest rate freeze and the upward revision of the growth forecast to 4.0%?

= Even considering current economic indicators, uncertainties remain regarding the future development of COVID-19 and the pace of vaccination. The progress of vaccination will significantly affect the speed of economic recovery. The optimistic scenario assumes faster vaccination and quicker normalization of economic agents' sentiment than expected. Also, if domestic consumption recovers and the growth trend in exports and investment expands, the growth rate could be much higher than the previous forecast.

▲ What is the possibility of an interest rate hike within this year?

= There was much discussion on this topic at today's Monetary Policy Committee meeting. To prepare for the possibility of an economic downturn due to COVID-19, an unprecedented level of monetary easing is being maintained. If the economic situation improves, it will be necessary to appropriately adjust the extraordinary easing measures according to the economic conditions. We should not rush just for normalization, but we also consider that delaying too much could have significant side effects. We are in a difficult position where we must neither rush nor delay. How to orderly adjust monetary policy is an important task. We are thoroughly preparing. Whether to raise rates within this year depends on how the economic situation unfolds. We will operate monetary policy appropriately while monitoring the speed and strength of economic recovery.

▲ Could the monetary policy stance be changed before the U.S. Federal Reserve (Fed)?

= The Fed's monetary policy greatly influences our domestic financial economy, so it is indeed a factor to consider when deciding monetary policy. However, fundamentally, it is appropriate to decide based on domestic economic conditions. In the past, there were cases where we adjusted interest rates before the U.S., and cases where the opposite happened. If the Fed maintains an easing stance and we adjust monetary policy first according to domestic conditions, it broadens our room for maneuver. I believe there is an advantage in being able to control the pace according to our situation. If we delay and then follow the Fed's hike, financial imbalances could widen. Also, adjusting the timing of interest rate policy based on external conditions could have side effects. We consider the Fed's monetary policy carefully but do not maintain monetary policy by directly matching it 1:1.

▲ Is there a possibility that current inflation will trend upward?

= Consumer prices rose by 2.3% in April. I expect it to be slightly higher in May. After that, it will ease somewhat and move around 2% in the second half of the year. Next year, as the base effect relatively disappears, it is expected to be around the mid-1% range. Recently, the rise in prices has been driven by oil and agricultural and livestock products. I think supply-side effects will decrease next year. The core inflation rate, which reflects overall demand pressure, is expected to continue rising next year due to economic improvement. The trend in inflation could change depending on structural factors.

▲ To what extent does the '4th disaster relief fund' affect this year's growth forecast?

= At the time of the February forecast, the details such as the scale of the disaster relief fund were not finalized, so it was not reflected in the forecast. The supplementary budget was confirmed at about 15 trillion won, and as far as we know, about 70% of it has been executed. The supplementary budget focused on self-employed and low-income groups with low consumption propensity, so it is believed to have had a greater effect on stimulating consumption compared to household transfer payments. Based on the Bank of Korea's macro-econometric model, it is estimated that this supplementary budget will raise the growth rate by 0.1 to 0.2 percentage points.

▲ Household debt at the end of Q1 is at a record high. How do you view the impact of interest rate hikes on household debt burden?

= If interest rates rise, the interest repayment burden on borrowing households inevitably increases. However, if this trend of increasing household debt continues further, the side effects will be considerable. Adjusting this later would require a greater cost. To prevent financial imbalances, household debt growth must be curbed and responded to without delay. If interest rates normalize gradually, the repayment burden on households must be considered, but we will do so in line with economic improvement. It is necessary to minimize the impact on household financial soundness.

▲ Considering the governor's term and next year's presidential election, some believe it will be difficult to raise the base interest rate.

= Monetary policy is not decided by me personally. The Monetary Policy Committee decides based on financial and economic conditions. I want to emphasize that the decision to raise the base interest rate is unrelated to the governor's term or political schedule.

▲ Could the introduction of Central Bank Digital Currency (CBDC) be accelerated?

= It is not easy to specify the exact timing for CBDC introduction. Technical issues are important, but institutional and legal factors also matter. The payment environment is rapidly changing now and is expected to continue changing significantly. Therefore, the need for a safe digital currency without credit risk and liquidity risk may increase. We will soon start pilot experiments and continue to study whether there are any points to improve based on them.

▲ Bitcoin volatility has recently increased. What role can the Bank of Korea play regarding this movement?

= The cryptocurrency market has rapidly expanded recently. There is a possibility that it could negatively affect financial system stability through various channels, so we are paying close attention. If individual investments in cryptocurrencies using leverage increase excessively, the risk of household losses could increase due to the volatile nature of cryptocurrencies. This could lead not only to household losses but also to loan defaults in related financial institutions. The Bank of Korea will closely monitor household loan trends, the scale of deposits and withdrawals linked to cryptocurrency transactions in bank accounts, and cooperate closely with the government.

▲ There have been ongoing discussions about adding employment stability to the Bank of Korea's mandate. What is your position on this?

= Five bills to amend the Bank of Korea Act have been submitted to the National Assembly. There are some discussions about priorities and various opinions have been presented. The Bank of Korea fundamentally agrees with the legislative intent that the central bank's contribution to the national economy should be enhanced through the introduction of an employment mandate. However, even if an employment mandate is introduced, it must not undermine the central bank's basic duties of price stability and financial stability. If employment stability is added to the mandate, discussions will be needed on how to consistently implement monetary policy under multiple policy objectives.

▲ Can inflation rates exceeding 2% be tolerated?

= The U.S. now uses an average inflation targeting system, so it tolerates inflation exceeding 2%. Our price stability target system is also a flexible inflation targeting system, not a rigid one. It does not set a specific point in time but aims to converge to 2% over the medium term. I want to emphasize that it is not about rigidly hitting 2%. Also, monetary policy decisions consider not only inflation forecasts but also economic conditions and financial stability comprehensively.

▲ What impact does the U.S. tapering (asset purchase reduction) discussion have on the Bank of Korea?

= Since Korea does not conduct large-scale asset purchases, this does not apply to us. The extraordinary financial stability special loan program and the expansion of eligible collateral securities implemented in response to COVID-19 have already been reversed. The remaining measure is the operation of the corporate bond and commercial paper purchase facility. We plan to review the funding conditions of self-employed and companies before deciding on any extension.

▲ Are there plans to purchase government bonds this month?

= The Bank of Korea announced plans in February to purchase a total of 5 to 7 trillion won in government bonds during the first half of this year. I believe the market has already priced in the Bank of Korea's government bond purchase plans. It is appropriate to carry out simple government bond purchases as announced. We will purchase the remaining amount by the end of June while monitoring market conditions. If deemed necessary due to sudden market interest rate fluctuations, we plan to implement market stabilization measures including government bond purchases.

▲ There are criticisms that Monetary Stabilization Bonds (MSBs) are not counted as government debt. What is your view?

= MSBs are liabilities of the Bank of Korea arising from the implementation of monetary policy. Since the government does not repay principal and interest, it is standard not to classify them as national debt. According to International Monetary Fund (IMF) standards, they are excluded, so it is inappropriate for only Korea to include MSBs in national debt. MSBs are issued to absorb liquidity for purposes such as securing foreign currency assets, stable exchange rate management, and price stability. Issuing MSBs results in corresponding foreign currency assets. Since issuing MSBs increases foreign currency assets, they should not be regarded as equivalent to national debt.