[Interest Rate Hike] BOK Base Rate 0.5%→0.75%, Additional Increase in October? (Comprehensive Report 3)

Bank of Korea Projects 4.0% Growth and 2.1% Inflation Rate for This Year

Household Debt Surpasses 1,800 Trillion Won and Housing Prices Soar… Bank of Korea Transforms into a 'Housing Price Fighter'

Steady Growth at '4.0% Annual Rate', Supported by Interest Rate Hikes

Inflation Forecast at 2.1% This Year… Proactive Response to US Tapering

[Asia Economy Reporters Eunbyeol Kim, Sehee Jang] The Bank of Korea (BOK) has ended the era of ultra-low interest rates by raising the base rate to 0.75% per annum. This comes 15 months after applying the historically lowest base rate of 0.50% per annum in response to the COVID-19 pandemic.

On the 26th, the BOK's Monetary Policy Board held a policy direction meeting at the BOK headquarters in Jung-gu, Seoul, chaired by Governor Lee Ju-yeol, and announced that the base rate was raised from 0.50% to 0.75%. This is the first rate hike by the BOK in 33 months since November 2018. Although uncertainties related to COVID-19 remain, the decision reflects the judgment that the rapid increase in household loans and rising housing prices and inflation can no longer be ignored. Despite strong loan regulations by financial authorities, debt continues to increase, so now the BOK intends to respond with the 'interest rate hike' card.

At a press conference immediately after the rate hike, Governor Lee said, "Private consumption has somewhat slowed due to the resurgence of COVID-19, but exports have remained strong and facility investment has shown a steady trend," adding, "The domestic economy is expected to continue its recovery gradually, centered on private consumption, supported by expanded vaccination and the execution of supplementary budgets." The BOK maintained its growth forecast for this year at 4.0%, the same as in May, and projected 3.0% growth for next year. Even with the rate hike, the level remains accommodative, and Governor Lee does not expect the rate increase to negatively impact the economy. He stated, "While raising rates has the effect of dampening consumption and investment, the real interest rate is still negative, and considering liquidity supply conditions and private credit trends, it is unlikely to have a negative impact strong enough to change the fundamental trend of the real economy."

The BOK also raised its inflation forecast for this year from 1.8% to 2.1%, an increase of 0.3 percentage points. Consumer price inflation has exceeded the BOK's 2% target for four consecutive months, acknowledging that inflationary pressures are stronger than expected. The inflation forecast for next year was also raised from 1.4% to 1.5%.

On the morning of the 26th, Lee Ju-yeol, Governor of the Bank of Korea, presided over the Monetary Policy Committee meeting held at the Bank of Korea in Jung-gu, Seoul, and struck the gavel.

The market now anticipates that the BOK may implement an additional rate hike at the next Monetary Policy Board meeting in October. Governor Lee said, "Although uncertainties related to COVID-19 continue, the domestic economy is expected to maintain a solid growth trend, and inflation is expected to remain above 2% for some time," adding, "We will gradually adjust the degree of monetary policy accommodation going forward." Regarding the timing of further rate hikes, he added, "We will carefully review the progression of COVID-19, changes in growth and inflation, accumulated risks of financial imbalances, and changes in major countries' monetary policies before making a decision."

Among the 38 member countries of the Organisation for Economic Co-operation and Development (OECD), Korea was the seventh country to raise interest rates this year. Countries that raised rates earlier than Korea this year include Mexico, Iceland, the Czech Republic, Chile, Turkey, and Hungary, most of which are emerging economies with high inflation concerns. Among Asian countries, Korea was the first to raise rates since the outbreak of COVID-19. Among advanced economies, New Zealand has hinted at a possible rate hike by the end of this year, and Norway has indicated a rate hike in September.

Household Debt Surpasses 1,800 Trillion Won and Housing Prices Soar… Bank of Korea Transforms into a 'Housing Price Fighter'

Governor Lee began mentioning the base rate hike starting in May. Until April, he said, "It is too early to consider a policy shift," but after presenting the annual growth forecast of 4.0% in May, he stated, "If the economic situation improves, it will be necessary to adjust the exceptional accommodative measures." In his 71st anniversary 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 the year, the BOK emphasized uncertainties and economic downturn due to COVID-19, but the biggest reason for its transformation into a 'hawk' is 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 is larger than the 36.7 trillion won in the first quarter. Compared to a year ago, it increased by 168.6 trillion won (10.3%), the largest increase since related statistics began in 2003. The growth rate exceeding 10% is 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 growth accelerated, 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 regulation, and raising interest rates together is judged to be more effective.

The Blue House and government also agree on the necessity of rate hikes. Lee Ho-seung, Chief of Policy Office at the Blue House, recently said, "If adjustments are not made proactively along the path of monetary policy normalization, it could become a significant factor of financial instability." Professor Donghyun Ahn of Seoul National University's Department of Economics evaluated, "If the household loan problem is serious, solving it with monetary policy in one go has a strong impact," adding, "Ultimately, the BOK has placed emphasis on the asset price bubble."

Steady Growth at '4.0% Annual Rate', Supported by Interest Rate Hikes

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

As people have adapted to the COVID-19 situation, consumption has remained stable even with a surge in confirmed cases, and exports continue 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 approvals in July amounted to 14.0517 trillion won, an increase of 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 value 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 actually rose, benefiting from seasonal demand like vacation season. The second supplementary budget of 34.9 trillion won, expected to be executed in earnest from mid-month, is also anticipated to support the economy.

Inflation Forecast at 2.1% This Year… Proactive Response to US Tapering

The BOK raised its inflation forecast for this year from 1.8% to 2.1%. Through the 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 (asset purchase reduction) also supported the BOK's rate hike. By raising rates proactively while the US signals tightening, the BOK can maintain the gap with US policy rates and minimize capital outflow risks.