[Weekly Review] Base Interest Rate Raised Four Consecutive Times for the First Time Ever... Inflation Forecast Hits Highest in 24 Years

Bank of Korea Raises Base Interest Rate from 2.25% to 2.50%
Maintains Hike Stance Amid Soaring Inflation and Won-Dollar Exchange Rate
Inflation Forecast for This Year at 5.2%, Highest Since 1998
Trade Deficit Deepens... $10 Billion This Month

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

The Bank of Korea raised the base interest rate four consecutive times for the first time in history. Despite significant uncertainties such as downside risks to the domestic economy, it judged that it was necessary to continue the rate hike stance as inflation is expected to remain on a high upward trend for the time being and the won-dollar exchange rate is soaring. In fact, the won-dollar exchange rate showed a volatile trend this week, rising to the highest level in 13 years and 4 months.

Base Interest Rate Raised from 2.25% to 2.50%... Four Consecutive Increases

At the monetary policy meeting on the 25th, the Bank of Korea's Monetary Policy Committee raised the base interest rate by 0.25 percentage points from 2.25% to 2.50% per annum. The Bank of Korea took this unprecedented step of raising rates four consecutive times for the first time in history because the need to quickly curb the rapid inflation remains significant. Governor Lee Chang-yong said at a press conference held immediately after the regular Monetary Policy Committee meeting, "It is desirable to operate monetary policy focusing on inflation for the time being and to continue the rate hike stance."

Governor Lee confirmed that the existing forward guidance, which states that rates will be raised gradually by 0.25 percentage points (25bp, where 1bp = 0.01 percentage points) for the time being, is still valid. Regarding the possibility of a big step (a 0.50 percentage point increase in the base rate), he said, "In principle, it can be considered if a shock occurs, but it is not considered under the current circumstances." He also evaluated the market expectation that the year-end base rate will be around 2.75?3.00% as "reasonable."

Seoul traditional market scene
[Image source=Yonhap News]

Inflation Rate Forecast for This Year at 5.2%... Highest in 24 Years

As the Bank of Korea raised the base interest rate, it also raised the consumer price inflation forecast for this year by 0.7 percentage points from the previous May forecast of 4.5% to 5.2%. This is the highest level in 24 years since 1998 (9.0%). If inflation rises to the 5% range as forecasted by the Bank of Korea, it will also be the highest record in 24 years since 1998 (7.5%).

The Bank of Korea expects inflation to slow down somewhat in August due to a slight drop in international oil prices compared to July, but to rise again to the 6% range in September and October due to heavy rains causing agricultural product price increases and the Chuseok holiday effect. It explained that inflation will gradually stabilize, recording an average increase of 5.9% in the second half of the year, 4.6% in the first half of next year, and 2.9% in the second half. The point at which monthly inflation falls below 3% is expected to be after mid-next year.

The economic growth forecast for this year was lowered from 2.7% to 2.6%. Kim Woong, head of the Bank of Korea's Research Department, explained, "We reflected major downside economic factors such as the possibility of economic slowdown due to US interest rate hikes, a 1?2 percentage point decline in European growth due to Russia's gas supply cut, and uncertainties in the Chinese economy due to zero-COVID policies." He added, "The growth trend in South Korea is also expected to weaken after the second half of the year."

On the morning of the 24th, an employee is organizing dollars at the Hana Bank Counterfeit Response Center in Jung-gu, Seoul. [Image source=Yonhap News]

Exchange Rate Surpasses 1,340 Won... Won Weakening Intensifies

The exchange rate continued its high-level march this week, surpassing 1,340 won for the first time in 13 years and 4 months. According to the Bank of Korea, the won-dollar exchange rate rose to 1,346.60 won intraday on the 23rd. This is the highest level since April 29, 2009 (high of 1,357.5 won) during the financial crisis. The won-dollar exchange rate crossed the 1,300 won level on June 23 and has been breaking new highs, reaching 1,310 won and 1,320 won on the 6th and 15th of last month, respectively.

The reason for the strengthening of the dollar is that the US Federal Reserve (Fed) has shown its intention to continue raising the base interest rate to curb severe inflation. Additionally, concerns about economic slowdown in Europe due to the Ukraine war and forecasts of a slowdown in China's growth have spread, further strengthening the preference for the dollar.

In response, President Yoon Suk-yeol expressed concern on the 23rd, saying, "We will manage risks well through emergency economic meetings to ensure that the strong dollar and weak won currency situation does not negatively affect our market." Bang Ki-sun, First Vice Minister of Strategy and Finance, held a macroeconomic and financial meeting the day before and said, "There is a risk that one-sided sentiment in the foreign exchange market may expand," adding, "If market sentiment becomes one-sided or speculative movements increase, we will take timely market stabilization measures."

On the morning of the 11th, container unloading operations are underway at Busan Port Sinsundae Pier. [Image source=Yonhap News]

Trade Deficit Exceeds $10 Billion This Month... Export Concerns Spread

South Korea's trade deficit is worsening. According to the Korea Customs Service, the trade deficit exceeded $10 billion from the beginning of this month to the 20th. As a result, the possibility of a full-month trade deficit in August has increased, which would mark five consecutive months of monthly trade deficits for the first time in over 14 years. The cumulative trade deficit this year has already exceeded $20 billion, setting an annual record.

Exports from the 1st to the 20th of this month (provisional customs clearance basis) amounted to $33.424 billion, a 3.9% increase compared to the same period last year, but imports surged by 22.1% to $43.641 billion during the same period. By item, imports of crude oil (54.1%), semiconductors (24.1%), gas (80.4%), coal (143.4%), and passenger cars (44.3%) increased significantly.

In particular, the trade balance with China recorded a deficit of $667 million from the 1st to the 20th of this month. The trade balance with China had recorded deficits for three consecutive months until last month. If it becomes a deficit for four consecutive months, it will be the first time since the establishment of diplomatic relations between South Korea and China in August 1992. On the 24th, Ahn Deok-geun, head of the Trade Negotiations Division at the Ministry of Trade, Industry and Energy, met with export officials and said, "The growth outlook for the global economy, including China, is being downgraded," adding, "Export conditions are challenging due to demand contraction caused by global inflation, leading to price declines in semiconductors, steel, and other products."