[On the Test Bench: Bank of Korea] 'Inflation Fighter' Revival... A Look Back at Past Price Wars

Prices Rose Sharply in 2008 and 2011
BoK Responded by Raising Base Rate Significantly
'Inflation Fighter' Revived Amid Recent Price Surge
Five Rate Hikes So Far, Big Step Expected in July
Economic Recession Likely After Inflation Peaks... Rapid Rate Cuts Anticipated

Bank of Korea Governor Lee Chang-yong held a briefing on the status of price stability target operations at the Bank of Korea press room in Jung-gu, Seoul, on the 21st of last month. Photo by Moon Ho-nam munonam@

The Bank of Korea's 'inflation fighter' instinct is being revived. It is not unusual for the Bank of Korea, which prioritizes price stability, to act as an inflation fighter during periods of rising prices, but the recent interest rate hikes are proceeding at the fastest pace since the introduction of the inflation targeting system in 1998. In particular, if the Bank of Korea raises the base rate by 0.5 percentage points at the July Monetary Policy Committee meeting as the market expects, it will simultaneously set records for the first-ever 'big step' and 'three consecutive hikes,' which is unprecedented even during the interest rate normalization process after the 2008 global financial crisis. 'Bank of Korea on the Test Bench'

Bank of Korea's Response to Inflation with Interest Rate Hikes

Over the past 20 years, the domestic consumer price inflation rate has exceeded 4% annually mainly in 2008 (4.7%) and 2011 (4.0%). In 2008, inflationary pressures intensified due to a sharp rise in international oil and raw material prices, with prices rising 5.5% in the third quarter and continuing an upward trend for 19 months. In 2011, during the economic recovery after the global financial crisis, inflation surged, recording a 4.3% increase in the third quarter. The inflationary trend then lasted for a remarkable 26 months. As of the second quarter this year, the inflation rate is 5.4%, and the upward trend has continued for about 20 months, making the current situation similar to those periods.

During such inflationary periods, the Bank of Korea generally followed with interest rate hikes. From 2005, before inflation rose in 2008, as economic growth accelerated centered on exports and real estate prices soared, the base rate was raised seven times from 3.25% in October to 5% by August 2007. Subsequently, as import prices began to rise significantly in the fourth quarter of 2007, the Bank of Korea raised the base rate once more in August 2008 to an all-time high of 5.25%.

During 2010-2011, when economic growth and inflation appeared together after the 2008 global financial crisis, a normalization process was carried out to raise the lowered interest rates again. Accordingly, the base rate, which was 2% in July 2010, was raised five times until June 2011, reaching 3.25%.

Recently, under the policy stance of 'prioritizing inflation over the economy,' the Bank of Korea has continued to raise interest rates steadily. As demand recovered after the COVID-19 pandemic and inflationary pressures intensified, the Bank raised rates five times from August last year to May this year, and it is highly likely to raise rates again this month and next month.

On the 8th, citizens are shopping at a large supermarket in downtown Seoul. Photo by Mun Ho-nam munonam@

Will the Interest Rate Hike Stance Change After Inflation Peaks?

The market expects the Bank of Korea's interest rate hikes to proceed more aggressively than in the past. The forecast that the Monetary Policy Committee will take a 'big step' for the first time this week is a representative example. Since the recent inflation surge is due to the Ukraine war, China's lockdown measures, and the highest inflation in 41 years in the U.S., it is difficult to compare with past cases on the same level. According to the minutes of the Monetary Policy Committee released last month, one committee member pointed out, "Unlike past supply shocks, various core inflation measures excluding food and energy, sticky inflation, and adjusted average inflation are showing clear upward trends, so it is necessary to actively respond to secondary ripple effects."

However, inflation typically peaks and then falls sharply, so depending on domestic and international economic conditions, there is a possibility that the interest rate hike stance could change 180 degrees. In fact, when the global financial crisis triggered by the Lehman Brothers bankruptcy began in September 2008, the Bank of Korea suddenly stopped raising rates in October and cut rates six times over five months by a total of 3.25 percentage points. At that time, the Bank even held an emergency Monetary Policy Committee meeting to lower rates. Also, in mid-2011, when the European fiscal crisis intensified, the Bank changed its monetary policy direction and cut rates eight times over four years starting in July 2012.

Recently, as concerns about economic recessions in major countries including the U.S. and Europe are growing, the possibility of a change in the interest rate hike stance around the first half of next year cannot be ruled out. Professor Kim Young-ik of Sogang University Graduate School of Economics said, "The economy will enter a recession next year."