First Four Consecutive Interest Rate Hikes... Inflation Forecast Raised to 5.2% (Comprehensive)

BoK Raises Rate by 0.25%P to 2.50%
Unanimous Decision by 7 Monetary Policy Committee Members
Rate May Reach 3.00% by Year-End
Growth Forecast Downgraded to 2.6%

Lee Chang-yong, Governor of the Bank of Korea, is presiding over the regular Monetary Policy Committee meeting held on the 25th at the Bank of Korea in Jung-gu, Seoul. Photo by Joint Press Corps

[Asia Economy reporters Seo So-jeong and Moon Je-won] The Monetary Policy Committee of the Bank of Korea raised the base interest rate by 0.25 percentage points to an annual rate of 2.50% on the 25th. The MPC had previously raised the base rate in meetings held in April, May, and July, and with this month's increase, it set a record for the first-ever four consecutive rate hikes.

The Bank of Korea also revised this year's consumer price inflation forecast to 5.2%, the highest since the implementation of the price stabilization target system in 1998, clearly signaling its intention to continue the rate hike trend. If additional rate hikes occur in the remaining MPC meetings this year (October and November), the year-end base rate could rise to as high as 3.00%.

Next year's inflation forecast was also raised by 0.8 percentage points from 2.9% to 3.7%. However, with growing concerns over a global economic recession, a slowdown in the U.S. and Chinese economies, a bleak export outlook in the second half, and the combined effects of rising prices and interest rates potentially reducing consumption, the Bank of Korea is expected to face significant challenges in determining future monetary policy directions.

◆ Highest inflation rate in 24 years = On the day, the Bank of Korea's Monetary Policy Committee held a monetary policy decision meeting and unanimously raised the base interest rate from 2.25% to 2.50% per annum. This year, the base rate was increased by 0.25 percentage points each in January and April, by 0.50 percentage points in July, and by an additional 0.25 percentage points on this day, returning to the 2.50% level last seen in August 2014.

The Bank of Korea's unprecedented move to raise rates four consecutive times despite concerns about economic slowdown is because "controlling inflation" is a more urgent matter. Although recent declines in international oil and grain prices have raised expectations that inflation has peaked, prices, which have risen to the 6% range, are not easily controlled. The expected inflation rate for the next year, which corresponds to the inflation expectations, fell by 0.4 percentage points this month to 4.3% from the record high of 4.7% in July, but it still remains at a high level in the 4% range.

In its revised economic outlook on the day, the Bank of Korea adjusted the consumer price inflation forecast, currently at 4.5%, upward by 0.7 percentage points to 5.2%. If inflation reaches the 5% range, it will be the highest in 24 years since 1998 (7.5%). The inflation forecast itself is the highest since the implementation of the price stabilization target system in April 1998. Professor Lee In-sil of Sogang University Graduate School of Economics said, "Domestically, the high inflation situation is expected to continue into the second half of the year," adding, "Since inflation expectations remain high in the 4% range, the Bank of Korea should now prioritize inflation over economic slowdown in conducting monetary policy."

Bank of Korea Governor Lee Chang-yong said, "Although downside risks to the domestic and international economy have increased, high inflationary pressures and inflation expectations continue," and added, "It is necessary to continue policy responses to prevent the entrenchment of the high inflation situation."

◆ Widening interest rate gap between Korea and the U.S. again = The interest rate inversion between Korea and the U.S. is also a factor behind the MPC's rate hike. The U.S. Federal Reserve (Fed) raised the policy rate by a giant step (0.75 percentage points) consecutively at last month's Federal Open Market Committee (FOMC) meeting, pushing the upper bound of the U.S. policy rate to 2.50%, higher than Korea's 2.25%. With the Bank of Korea's 0.25 percentage point hike this month, the upper bounds are now equal, but if the U.S. takes another big step (0.50 percentage points) or giant step next month, the interest rate gap between Korea and the U.S. will inevitably widen further. Jo Young-moo, a research fellow at LG Economic Research Institute, expressed concern, saying, "For the Korean won, which is not a key currency like the dollar, if the interest rate gap reverses or narrows, foreign investment funds may flow out, and the resulting sharp rise in the won-dollar exchange rate could fuel inflation."

In particular, the recent sharp rise in the won-dollar exchange rate has added inflationary pressure and provided a pretext for interest rate hikes. To curb the relentless rise in the exchange rate, foreign exchange authorities intervened verbally for the first time in two months, but it was insufficient to stop the upward trend. On the 23rd, the won-dollar exchange rate surged to 1,346.6 won intraday, setting a new yearly high.

◆ Divergent views on future big steps = Experts agreed on the necessity of rate hikes by the MPC in the second half but showed differing opinions on the big step approach of raising the base rate by 0.5 percentage points at once. Professor Kang Sung-jin of Korea University’s Department of Economics said, "Although the exchange rate has risen significantly, inflation seems to be slightly slowing down, so it is not easy for the Bank of Korea to choose a big step." On the other hand, Cho Kyung-yeop, head of economic research at the Korea Economic Research Institute, said, "Considering inflation and exchange rate issues, it is necessary to somewhat align with the U.S. base rate to reduce medium- to long-term burdens, so a big step should be considered in the future."

On the day, the Bank of Korea lowered its real gross domestic product (GDP) growth forecast for this year from 2.7% to the 2.6% range. The growth forecast for next year was also lowered by 0.3 percentage points from 2.4% to 2.1%. This is because export growth may slow due to economic downturns in the U.S., China, and other countries, and consumption may decline due to inflation and interest burdens. Professor Kang said, "Currently, exports are increasing, but imports are increasing even more, causing an expansionary deficit, so growth is expected to continue to decline until oil prices stabilize completely," adding, "This is a global phenomenon, not just in Korea, so difficult conditions will continue this year."