Putting Out the Urgent Inflation Fire... Drastic Measures Even Without the Bank of Korea Governor (Comprehensive Report 2)

Bank of Korea Returns to 1.50% Annual Rate
Inflation Pressure Despite Governor Vacancy
May US Big Step Also Influences Hike
Inflation Nears 4% This Year, Growth in Mid-to-High 2% Range

Joo Sang-young, Acting Chairman of the Monetary Policy Committee, is presiding over the Monetary Policy Committee meeting held at the Bank of Korea in Jung-gu, Seoul on the morning of the 14th. 2022.04.14. Photo by Joint Press Corps

[Asia Economy Reporter Seo So-jeong] The Bank of Korea tightened monetary policy by raising the base interest rate again after three months since January, despite the governor position being vacant. As a result, the base rate has returned to the pre-COVID-19 level of 1.50% per annum last seen in July 2019.

Although the absence of a governor initially raised concerns about a rate hike in May, recent red flags in economic indicators such as inflation and the accelerating tightening stance of the U.S. Federal Reserve (Fed) led to concerns about a potential 'missed opportunity,' which is interpreted as a factor that expedited the decision to raise rates.

On the 14th, the Bank of Korea's Monetary Policy Committee (MPC) held a meeting to decide monetary policy direction and announced a 0.25 percentage point increase in the base rate from 1.25% to 1.50%. The meeting was chaired by MPC member Joo Sang-young, acting as chair due to the upcoming confirmation hearing of the Bank of Korea governor nominee, Lee Chang-yong. The rate hike was decided unanimously by the six MPC members excluding the governor.

At an online press conference following the rate decision, Chair Joo explained the background of the hike, saying, "Since the MPC meeting at the end of February, significant changes have occurred in domestic and international economic and financial conditions, including the Ukraine crisis. We judged that inflationary pressures might last longer than expected due to the Ukraine situation, and despite the governor vacancy, we could not avoid responding." He added that the decision focused on domestic inflation and growth trends.

Base Rate Rises a Total of 1.00 Percentage Point in 8 Months

Previously, on March 17, 2020, anticipating an economic recession due to the COVID-19 pandemic, the MPC cut the base rate by 0.50 percentage points at once and further lowered it by 0.25 percentage points on May 28 of the same year, totaling a 0.75 percentage point cut within two months.

After nine consecutive freezes, the MPC signaled 'normalization of monetary policy' by raising the rate by 0.25 percentage points on August 26 last year, the first hike in 15 months. Since then, the base rate has been raised four times by 0.25 percentage points each in November last year, January this year, and today, totaling a 1.00 percentage point increase over about eight months.

The MPC's sudden decision to raise rates despite the unprecedented situation of a governor vacancy reflects the judgment that recent inflationary pressures have reached an unmanageable level. Due to the Ukraine crisis, international oil prices surged, causing the consumer price index (CPI) in March to jump 4.1% compared to the same month last year. A rise above 4% is the first in 10 years and 3 months since December 2011 (4.2%).

The problem lies in the expectation that inflation will rise further. Chair Joo projected that the consumer price inflation rate will remain in the high 4% range for some time, significantly exceeding the Bank of Korea's February forecast of 3.1% for the annual inflation rate. He said, "This year, the domestic gross domestic product (GDP) growth rate is expected to slightly underperform the February forecast of 3%, while consumer prices will continue to rise strongly in the 4% range for the time being. Since the domestic economy is expected to maintain its recovery and inflation will exceed the target level for a considerable period, we will appropriately adjust the degree of monetary policy easing going forward."

Through March this year, the cumulative consumer price inflation rate has already reached 3.8%. At the Bank of Korea's 'Inflation Situation Review Meeting' on the 5th, it was analyzed that the consumer price inflation rate would not fall below the 4% range for some time. According to the Bank of Korea's March Consumer Sentiment Survey, the expected inflation rate reached 2.9%, the highest in 7 years and 11 months.

The possibility that the U.S. Fed may implement a 'big step' of raising rates by 0.5 percentage points at once as early as May to curb inflation is also cited as a factor for the base rate hike. According to the U.S. Department of Labor, the U.S. consumer price index (CPI) in March surged 8.5% year-on-year, marking the largest increase since December 1981. Amid the highest inflation in 40 years, Fed officials have repeatedly emphasized the need to quickly raise the base rate to a neutral level.

A rate inversion between Korea and the U.S. could become a reality. If the U.S. implements a 0.5 percentage point 'big step' rate hike in May and continues with additional hikes, the inversion could occur within a few months. This raises concerns about capital outflows by foreign investors and depreciation of the Korean won. However, Chair Joo commented on the Korea-U.S. rate inversion, saying, "Since the fundamentals of the Korean economy are sound, the possibility of large-scale capital outflows is low."

It is also analyzed that the new government's prioritization of stabilizing livelihoods, including inflation, contributed to the rate hike decision. President-elect Yoon Suk-yeol instructed the Presidential Transition Committee on the 6th to "make stabilizing livelihoods, including inflation, the top priority of the new government."

Going forward, market attention will focus on whether the MPC will implement additional rate hikes at the May meeting. Professor Sung Tae-yoon of Yonsei University's Department of Economics said, "Initially, the market expected one rate hike between the April and May MPC meetings, but with the Fed's strong indication of a big step, the possibility of an additional hike in May cannot be completely ruled out." Regarding the decision to raise rates amid the governor vacancy, a Bank of Korea official said, "Despite the governor vacancy, the decision to raise rates demonstrates the independence and stature of the MPC as a collegial body."

Meanwhile, the MPC revised the Bank of Korea's lending and deposit rates for financial institutions on the same day, deciding to maintain the loan interest rate for the COVID-19 relief program for small and medium-sized enterprises and small business owners at 0.25% per annum starting from the 2nd of next month, while raising the loan interest rates for other regular support programs from 0.25% to 0.50% per annum.