[Interest Rate Hike] Bank of Korea Steps Up as 'House Price Fighter'... Also a Preemptive Move Against Inflation

[Image source=Yonhap News]

Concerns Over Uncontrollable Asset Bubble

Debt Increasing Despite Successive Loan Regulations... Household Debt Hits 1,800 Trillion Won Red Flag

Greater Effect When Accompanied by Monetary Policy

Inflation Rate Forecast at 2.1%... Inflation Rate in the 2% Range for the First Time in 9 Years

Robust Economic Growth at 4.0%

US Tapering Imminence Also a Factor for Interest Rate Hike

[Asia Economy Reporters Kim Eun-byeol, Jang Se-hee] The dominant interpretation is that the Bank of Korea’s (BOK) decision to end the ultra-low interest rate era of 0.50% per annum strongly reflects its sense of crisis over household debt and soaring housing prices. The BOK injected money at an unprecedented level in response to the COVID-19 pandemic, but in the market, ultra-low interest rates were leveraged to heavily invest in real estate and stocks. This has heightened concerns that household debt, along with the asset bubble, could balloon to uncontrollable levels. Additionally, the inflation concern has grown as this year’s inflation rate is expected to exceed 2% for the first time in nine years, which is also cited as a background for the interest rate hike.

Household Debt Surpasses 1,800 Trillion Won and Housing Prices Surge

BOK Governor Lee Ju-yeol began mentioning interest rate hikes starting in May. Until April, he said, "It is too early to consider a policy stance shift," but after presenting the annual growth forecast of 4.0% in May, he hinted, "If the economic situation improves, it is necessary to adjust the exceptional easing measures." In the ‘71st Anniversary Commemorative Speech’ in June, he identified ‘orderly normalization of monetary policy’ as a priority to be pursued in the second half of the year.

At the beginning of this year, the BOK, which emphasized uncertainty and economic sluggishness due to COVID-19, transformed into a ‘hawk’ mainly because of real estate. According to the BOK, as of the end of June, the outstanding household credit balance was 1,805.9 trillion won, an increase of 41.2 trillion won (2.3%) from the end of the previous quarter. This increase was larger than the first quarter’s 36.7 trillion won. Compared to a year ago, it rose by 168.6 trillion won (10.3%), the largest increase since related statistics began in 2003. The growth rate exceeding 10% is also the first time since the second quarter of 2017 (10.4%).

Despite strong regulations by financial authorities such as the Debt Service Ratio (DSR), household debt continued to rise sharply, and the average apartment sale price in Seoul in July surpassed 1.1 billion won for the first time ever. From the BOK’s perspective, financial authorities have done enough loan regulations, and raising interest rates together is judged to be more effective.

The Blue House and the government also agree on the necessity of raising interest rates. Lee Ho-seung, Chief of the Blue House Policy Office, recently said, "If adjustments are not made preemptively according to the normalization path of monetary policy, it could become a significant financial instability factor." Professor Ahn Dong-hyun of Seoul National University’s Department of Economics evaluated, "If the household loan problem is serious, solving it with monetary policy in one go is impactful," adding, "Ultimately, the BOK has placed emphasis on the asset price bubble."

‘4.0% Annual’ Robust Growth

The fact that the economy is holding up steadily also provided the foundation for the BOK to raise interest rates. The BOK maintained its economic growth forecast for this year at 4.0%. Although there were concerns that the recovery might slow due to the fourth wave of COVID-19 starting in July, it is expected to maintain the anticipated growth trajectory.

As people adapted to the COVID-19 situation, consumption remained stable despite a surge in confirmed cases, and exports continued to increase. The BOK judges that the damage from the fourth wave of COVID-19 this summer is not as severe as the first to third waves. Credit card approval amounts in July were 14.0517 trillion won, up 7.0% year-on-year and 2.3% month-on-month, indicating continued domestic demand recovery.

Corporate sentiment is also holding up thanks to exports. From the beginning of this month to the 20th, export amounts increased by 40.9% compared to the same period last year, and despite the fourth wave, the number of employed persons in July increased by more than 540,000 compared to a year ago. In the August Business Survey Index (BSI), manufacturing BSI declined, but non-manufacturing sectors such as services rose, benefiting from vacation season demand. The second supplementary budget (extra budget) of 34.9 trillion won, expected to be fully executed from mid-month, is also anticipated to support the economy.

Inflation Forecast Raised to 2% Range

The BOK raised its inflation forecast for this year from 1.8% to 2.1%. Through the interest rate hike, it aims not only to address debt but also to stabilize prices. Future inflationary pressures are significant. The expected inflation rate in August was 2.4%, the highest since December 2019, and the Producer Price Index has risen for nine consecutive months.

Last month, the International Monetary Fund (IMF) stated in its World Economic Outlook report that "inflation may persist longer and central banks may need to take preemptive measures." Additionally, the approaching US tapering (reduction of asset purchases) also supported the BOK’s interest rate hike. By preemptively raising rates while the US signals tightening, the BOK can maintain the gap with US policy rates and minimize capital outflow risks.