[Expert Panel of 5] "Interest Rate Hikes Will Stop Only When Inflation Falls to 3% Range"... Exchange Rate Stability Is the Biggest Challenge

"Considering South Korea's Economic Situation and Household Debt
Interest Rate Hike Pace is Reasonable"
Calls for Additional Big Step Raised
If Q4 Recession Becomes Clear
One More Hike May Conclude the Cycle

Won-Dollar Exchange Rate is an Economic Wildcard
Low Possibility of Stagflation

[Asia Economy Reporters Seo So-jung and Moon Je-won] At a crossroads of high inflation and economic slowdown, the Korean economy urgently needs a clever monetary policy more than ever. The Bank of Korea has clearly stated its intention to continue its rate hike stance until the end of this year, but as concerns about a global recession centered on Europe and the United States grow, there are also analyses suggesting the need to adjust the pace of monetary policy. Accordingly, Asia Economy held an emergency discussion with five economic experts to diagnose the economy and gather opinions on the Bank of Korea’s monetary policy.

◆ Inflationary pressures remain strong = Many economic experts evaluated that the Bank of Korea’s gradual rate hike stance is reasonable, given that the high consumer price increase of 5-6% is expected to continue until early next year.

Professor Ha Jun-kyung of Hanyang University said, "There is a need to be more aggressive in curbing inflation, but there are no proper means to manage the side effects of rapid rate hikes, and considering the current Korean economic situation and household debt, the current pace of hikes is appropriate." Professor Kim Tae-gi of Dankook University said, "Inflationary pressure in the U.S. is much stronger than ours," adding, "If the Bank of Korea implements a big step (a 0.50 percentage point increase in the base rate), it could rather bring about a recession, so gradual hikes are desirable." Although downside risks to growth are increasing, due to significant uncertainties related to the pace of the U.S. Federal Reserve’s rate hikes, monetary policy should be operated with gradual increases while closely monitoring domestic and international situations.

Since the annual inflation forecast has hit the highest level in 24 years at the 5% range, opinions were also presented that big steps should not be ruled out. Professor Shin Se-don of Sookmyung Women’s University pointed out, "To bring inflation down to the 3% range within 1-2 years, a 0.25 percentage point hike is insufficient," adding, "If the U.S. Fed takes a giant step (a 0.75 percentage point increase) next month, the interest rate gap between Korea and the U.S. will widen further, so additional big steps are needed until the end of this year." Professor Shin expressed concern that "while commodity prices symbolically drive inflation, service prices have a greater impact," noting, "Recently, domestic service prices have surged sharply, and since service prices include labor costs, once they rise, they do not easily fall." It is expected that rate hikes will stop only when inflation falls to the 3% range, and below 3%, downside pressure on the economy will be greater.

However, there is also a view that the rate hike cycle will end early as a recession becomes visible in the fourth quarter. Professor Kim Young-ik of Sogang University said, "I expect the Bank of Korea to raise rates once more in October and then finish the rate hike cycle," explaining, "This is because the Korean economy is expected to return to negative growth in the fourth quarter due to a decline in exports." Professor Kim predicted, "Interest rates affect industry, production, and consumption with about a six-month lag," adding, "The rate hikes already implemented will show effects in the first half of next year, leading to demand contraction."

[Image source=Yonhap News]

◆ The biggest challenge is stabilizing the foreign exchange market = In particular, the recently soaring won-dollar exchange rate is expected to be a wild card that will influence the Korean economy in the second half of the year. Professor Shin emphasized, "The biggest problem in Korea right now is that the exchange rate is unstable, throwing the financial market into chaos," adding, "To prevent this, it is necessary to curb the rapid rise in the exchange rate through rate hikes." He warned, "The current situation is like a bomb cocktail combining interest rate inversion and exchange rate risk," and "Until the next U.S. Federal Open Market Committee (FOMC) meeting, the exchange rate is expected to fluctuate severely, and amid greatly expanded foreign exchange volatility, it will basically follow an upward trend but repeat rises and falls."

Meanwhile, although exports that have driven the Korean economy are slowing and the trade balance deficit continues, the prevailing view is that the Korean economy is indeed in a crisis but the possibility of entering stagflation is low. Professor Kim Tae-gi said, "Key industries such as automobiles, semiconductors, and secondary batteries are performing relatively well, and as oil and grain prices stabilize, the rapid inflation trend has slightly eased, so it is hard to see this as stagflation," suggesting, "Going forward, the government should focus on enhancing industrial competitiveness."

Professor Kim Jin-il of Korea University also said, "Since there are many variables in domestic and international situations, the ability to respond quickly when problems arise is important," urging, "The government should strengthen domestic and international monitoring so that it can land safely without breaking anything during crises." Professor Ha added, "It is important to reduce the public’s pain from macroeconomic factors that were previously unthinkable, such as high inflation, high interest rates, and high exchange rates," and added, "The government should take the lead in investing in infrastructure and implementing labor supply policies like the U.S. to expand supply capacity and prepare for prolonged crises."