Is US Tightening Pausing Amid Ukraine Crisis... South Korea Also on Alert for Interest Rate Hike

Russia-Ukraine War... US Big Step May Stall
Inflation Concerns... Bank of Korea Eyes Timing of Rate Hike

A woman who lived here is screaming in front of an apartment building in Kyiv, the capital of Ukraine, which has become a pile of debris with walls torn apart after a rocket attack on the 25th (local time).
[Image source=AP Yonhap News]

As Russia's invasion of Ukraine raises the possibility of a delay in the aggressive tightening by the U.S. Federal Reserve (Fed), attention is also focused on the potential impact on South Korea's economy. Initially, the market expected the Fed to raise the benchmark interest rate next month, but given the growing economic shock from the Ukraine crisis, a slowdown in the pace of hikes is seen as inevitable.

According to the financial sector on the 26th, the Fed is expected to raise the benchmark interest rate, currently at 0.00?0.25%, at the Federal Open Market Committee (FOMC) regular meeting scheduled for March 15?16. This is because the need to respond through rate hikes is increasing as inflation in the U.S. has reached a severe level. In January this year, the U.S. consumer price inflation rate hit 7.5%, the highest in 40 years since 1982. The market even anticipated that the Fed might implement as many as seven rate hikes this year.

However, recent Russian aggression in Ukraine has increased uncertainty about the Fed's rate hike outlook after next month. Since Russia is a major oil producer, there are warnings that disruptions in oil supply caused by this war could lead to a sharp rise in oil prices and trigger stagflation. In a situation where the economic shock from the Ukraine crisis is intensifying, a sudden rate hike could potentially hamper the economic recovery.

Therefore, the financial sector suggests that it will be difficult for the Fed to take a big step of raising the benchmark interest rate by 0.50 percentage points at once. Mohamed El-Erian, Chief Economic Advisor at Allianz, said on CNBC, "The possibility of a 0.5 percentage point hike by the Fed has been completely eliminated due to this situation," adding, "The previously discussed 8 to 9 rate hikes have also been taken off the table."

Accordingly, there are opinions that the Bank of Korea's rate hike stance may also see some changes. If the U.S. takes a big step, pressure on the Bank of Korea to raise rates would inevitably increase, but given the heightened uncertainty from the Ukraine crisis, existing forecasts may change. South Korea has already raised rates consecutively in August and November last year, and January this year, resulting in a 1.00?1.25 percentage point gap with U.S. rates.

The Bank of Korea's Monetary Policy Committee unanimously decided to keep the benchmark interest rate unchanged on the 24th. Because of this, even if the Fed raises rates next month, there are voices suggesting that the Bank of Korea will not immediately follow suit. The Bank of Korea's decision to hold rates this time also considered the rapid spread of the Omicron variant and economic uncertainties stemming from the Russia-Ukraine situation.

Of course, many expect that the Bank of Korea's rate hike stance will not change significantly. Inflation is also rising sharply domestically. The Bank of Korea revised its consumer price inflation forecast for this year upward from 2% in November last year to 3.1% this time. This is the first time in about 10 years since April 2012 (3.2%) that the annual inflation forecast has reached the 3% range. At a press conference after the Monetary Policy Committee meeting, Bank of Korea Governor Lee Ju-yeol indicated the possibility of additional hikes within the year, saying, "Inflation is expected to continue for a considerable period, and since the risk of financial imbalances remains, it is appropriate to adjust the degree of easing accordingly."