[Haneun Big Step] Inflation Hits 7%... Will There Be Another Big Step in August?

October 7% Range Outlook, Highest in 24 Years
BOK Shows Commitment to Price Stability Through Big Step
Possibility of Consecutive Big Steps Next Month Raised
Concerns Over Economic Burden from Rapid Interest Rate Hikes

[Asia Economy Reporter Seo So-jeong] Lee Chang-yong, Governor of the Bank of Korea, made history by implementing the first-ever big step (a 0.50 percentage point increase in the base interest rate), strongly signaling his determination as an 'inflation fighter.' With forecasts suggesting that the domestic consumer price inflation rate could exceed 7% in October, there is an assessment that the Bank of Korea is seriously following the footsteps of 'Paul Volcker' to curb soaring prices. Volcker, the former chairman of the U.S. Federal Reserve (Fed), was known for taming inflation with aggressive interest rate hikes over 40 years ago. Especially as high inflation is expected to persist into the second half of the year, the market is keenly watching whether the Bank of Korea will take consecutive big steps at the upcoming Monetary Policy Committee meeting next month.

◆Expanding pace amid 7% inflation forecast for the second half= The reason behind the Bank of Korea's first-ever big step is the recent rapid spread of inflation. The consumer price inflation rate in June recorded over 6%, marking the highest level in 23 years and 7 months. The problem is that this upward trend is not yet at its peak. The financial investment sector predicts that the consumer price inflation rate will surge to the 7% range in October, reaching its peak.

If the 7% forecast materializes, it will be the highest level in 24 years since October 1998 (7.2%) during the period of rapid price increases. Park Seok-gil, Chief Economist at JP Morgan, predicted, "The consumer price inflation rate will continue in the 6% range during the second half of this year, peak at 7% in October, and then gradually decline." Due to ongoing global supply chain disruptions and the impact of post-COVID-19 recovery on daily life, including rising prices for services such as dining out, some forecasts suggest inflation could peak as early as July or August.

Experts evaluate this big step as a move by the central bank to demonstrate its determination to stabilize prices amid a phase where inflation expectations are rapidly spreading. Jo Young-moo, Research Fellow at LG Economic Research Institute, said, "Even if external factors trigger inflation, if inflation expectations spread domestically, it will cause a wage-price interaction leading to a vicious cycle," adding, "The big step can help lower inflation expectations."

The fact that the interest rate inversion between Korea and the U.S. is becoming more pronounced this month also triggered the big step. With the Bank of Korea raising the base rate by 0.50 percentage points to 2.25%, Korea's rate is currently 0.50 to 0.75 percentage points higher than the U.S. rate (1.50?1.75%). However, if the U.S. Fed takes a giant step (a 0.75 percentage point hike) at the Federal Open Market Committee (FOMC) meeting at the end of this month as expected, the U.S. base rate will become 0.00 to 0.25 percentage points higher than Korea's, reversing the interest rate order. For the Korean won, which is not a key currency like the dollar, an inversion or narrowing of interest rates can lead to foreign investor capital outflows, and the resulting sharp rise in the won-dollar exchange rate could further fuel inflation.

◆Possibility of consecutive big steps in August= Now, market attention is turning to the August Monetary Policy Committee meeting. Some cautiously suggest the possibility of consecutive big steps in August to counter the high inflation situation. Ha Jun-kyung, Professor of Economics at Hanyang University, said, "A year ago, the inflation rate was in the 2% range, but now it has jumped to 6%, so we cannot rule out any possibilities," adding, "Consecutive big steps are very unusual, but since recent inflation has also surged unusually, it is necessary to keep the possibility of consecutive big steps open."

On the other hand, concerns are growing that rapid interest rate hikes amid fears of a global economic recession could burden the economy. Research Fellow Jo said, "Despite this month's big step, the U.S. is expected to have a large rate hike, so the interest rate inversion between Korea and the U.S. cannot be prevented," and added, "With growth expected to be lower than anticipated this year and a high possibility of economic slowdown in the second half, consecutive big steps will be difficult."

Kim Jeong-sik, Emeritus Professor of Economics at Yonsei University, also said, "Even if the U.S. raises rates by 0.75 percentage points causing inversion, unless there are special abnormal signs in the foreign exchange market afterward, I expect baby steps to be taken, with rates reaching around 3.0% by the end of the year," adding, "Rapid hikes could deepen the recession, cause a real estate bubble burst, and increase interest burdens due to household debt." However, he emphasized that with exports supporting the Korean economy slowing down, the trade balance continuing its deficit streak, and the exchange rate recently hitting new highs, measures to address these issues are urgently needed.