[Base Interest Rate at 1% Era] Household Interest Burden This Year 5.8 Trillion Won... Could Rise to 1.75% Next Year

Household Credit in Q3 Reaches 1,845 Trillion Won... Continued Increase in Mortgage Loans
Experts Say "1.00% Annual Rate Still Accommodative"
Interest Rates Expected to Rise to 1.75% Next Year

[Asia Economy Reporter Jang Sehee] The Bank of Korea's decision to raise the base interest rate again after three months is interpreted as a strategic move to simultaneously curb soaring inflation and the surge in household debt. Despite the base rate recovering to the 1% range, many still consider it accommodative, leading to a dominant analysis that the Bank of Korea will further raise the base rate in January next year. As interest rates normalize, the burden of loan repayments for households and businesses is expected to increase further.

◆ Inflation forecast raised to 2.3%... Growing concerns over inflation = The main reason the Bank of Korea decided to raise the base rate this time is household debt and rising prices. If the current low interest rate environment continues, risk-taking behavior due to excessive borrowing could intensify. In the third quarter, household credit balance reached 1,844.9 trillion won. In particular, mortgage loans increased by 20.8 trillion won, which is 3.5 trillion won more than the previous quarter's 17.3 trillion won. In terms of growth rate, it recorded 8.5% year-on-year in the first quarter and 8.6% in the second quarter, continuing the upward trend.

Soaring inflation is also a problem. The Bank of Korea revised its inflation rate forecasts for this year and next year upward to 2.3% and 2.0%, respectively. This is higher than 2019 (0.4%) and 2020 (0.5%), indicating concerns about inflation. Professor Lee In-ho of Seoul National University’s Department of Economics said, "If the household debt problem were not this serious, they might have waited until the U.S. moved before taking action," adding, "Ultimately, they are proactively preparing according to our situation due to the deepening financial imbalance."

◆ Household interest costs increase by 6 trillion won = Following the additional base rate hike after August, household interest costs are expected to increase by about 6 trillion won annually. According to the Bank of Korea, if the base rate rises by 0.50 percentage points, annual household interest costs increase by 5.8 trillion won compared to 2020. This figure was calculated using loan balances and the proportion of variable-rate loans. However, the Bank of Korea explained that this is less than the 60.4 trillion won interest cost in 2018 when the rate was raised by 0.50 percentage points. The increase in interest burden for companies is also estimated to rise by 2.1 trillion won due to this hike. Professor Kim Sang-bong of Hansung University’s Department of Economics stated, "It is desirable to provide policy support such as microfinance for vulnerable groups who are socially disadvantaged."

◆ Additional hike likely in January... Will it rise to 1.75%? = Experts and the market expect the Monetary Policy Committee to raise the base rate by another 0.25 percentage points in January next year and possibly one or two more times in the second half of the year. If three additional hikes of 0.25 percentage points each occur next year, the final base rate will reach 1.75%. The Korea Capital Market Institute previously stated in its ‘2022 Economic and Capital Market Outlook’ report that the Bank of Korea might raise rates up to three times depending on economic conditions. The 10-year government bond yield is forecasted to range from a low of 2.2% to a high of 2.6%. Professor Kim said, "An annual rate of 1.00% is still accommodative," adding, "Considering the situations of major countries and domestic economic conditions, interest rate normalization should proceed between 1.25% and 1.75%." Inflation is expected to rise further due to increased heating demand at year-end and whether the Organization of the Petroleum Exporting Countries (OPEC) increases production. The phased return to normal life (With Corona) is also likely to increase demand-side inflationary pressures.

Bank of Korea Governor Lee Ju-yeol indicated additional hikes during a press conference immediately after the rate increase, stating, "The timing of further adjustments to the degree of monetary policy easing will be judged while monitoring the progression of COVID-19, changes in growth and inflation trends, accumulated financial imbalance risks, and changes in major countries’ monetary policies." Raising the rate to 1.25% in January next year would fully restore it to pre-COVID levels. However, it still remains 1 percentage point lower than the 2.5% level in July 2014, shortly after Governor Lee took office.

The market anticipates that raising rates in February will be burdensome, considering that the Monetary Policy Committee did not raise rates just before the last three presidential elections. In 2007 and 2012, when presidential elections were held, the rates were kept steady at 5.0% and 2.75%, respectively, citing weakening economic recovery. Before the 2017 presidential election, the Monetary Policy Committee unanimously kept the base rate at 1.25%. Professor Lee said, "If rates are raised, the economy could shrink, so the political sphere is likely to be reluctant to raise rates," adding, "The closer the election, the more the Monetary Policy Committee may feel the burden."