Lee Chang-yong "If Inflation Exceeds 5% Significantly, Prioritize Prices... Below 3% in Second Half of Next Year" (Summary)

Bank of Korea Governor Lee Chang-yong Interview at Jackson Hole
"BOK Not Independent from Fed, Difficult to End Rate Hikes Early"
If Fed Takes Giant Step Next Month and Big Steps in Nov-Dec
Interest Rate Gap Between Korea and US Will Widen

[Image source=Yonhap News]

[Asia Economy Reporter Seo So-jeong] Jerome Powell, Chairman of the U.S. Federal Reserve (Fed), forecasted a third giant step (a 0.75 percentage point increase in the benchmark interest rate) at the Jackson Hole meeting, complicating the Bank of Korea's (BOK) monetary policy calculations. BOK Governor Lee Chang-yong holds the view that a baby step (a 0.25 percentage point increase in the benchmark interest rate) is appropriate for domestic conditions, but he must act flexibly depending on the Fed's moves. Governor Lee's remark at the Jackson Hole meeting that "the BOK is not independent from the Fed" directly reflects this dilemma. His indication of the possibility of a monetary policy change if inflation falls below the 3% range in the second half of next year is in the same context.

In an interview with some foreign media (Bloomberg TV) on the 27th (local time) in Jackson Hole, Wyoming, USA, Governor Lee said, "If inflation remains around 5%, the normalization period of monetary policy will be extended," but he also questioned, "However, inflation is expected to fall below 3% by the end of next year, but who knows if that happens?" According to the BOK's August economic outlook, the consumer price inflation rate is expected to decrease from 4.6% in the first half of next year to 2.9% in the second half. Even if the rate hike trend continues in the first half, if inflation falls below 3% in the second half, the possibility of changing the direction of monetary policy cannot be ruled out.

When asked whether a big step (a 0.50 percentage point increase in the benchmark interest rate) is possible in the first half of next year if Korea's inflation remains above 5%, he said, "It is difficult to comment in advance due to the current high uncertainty such as international oil and gas prices, China's COVID-19 policy, and economic slowdowns in China and the U.S.," adding, "If inflation continues to significantly exceed about 5%, the BOK will prioritize price stability as Chairman Powell mentioned."

Governor Lee also expressed in another interview with foreign media that "the BOK's monetary policy is independent from the Korean government but not completely independent from the Fed's monetary policy," and lamented, "Although the BOK started raising rates ahead of the Fed in August last year, an early end is difficult."

The BOK Monetary Policy Committee raised the benchmark interest rate by 0.25 percentage points on the 25th, but with the Fed signaling a giant step next month, the possibility of raising the benchmark rate by at least another 0.5 percentage points by the end of this year has increased. Currently, the benchmark interest rates between Korea and the U.S. are the same at 2.50%, but if the Fed raises rates by 0.75 percentage points next month, the upper bound of the U.S. benchmark rate (3.00?3.25%) will be 0.75 percentage points higher than Korea's. Also, if the Fed takes big steps in November and December respectively and Korea's benchmark rate remains unchanged, the rate gap could reach 1.75 percentage points by the end of the year.

The U.S.'s aggressive rate hikes are a factor for the weakening of the Korean won; the won-dollar exchange rate has risen 11% this year, and the won's value last week hit its lowest in 13 years. The Fed's rate hikes could further weaken the won and cause stronger inflation in Korea.

Regarding this, Governor Lee said, "The interest rate gap itself is not our main policy goal, but if U.S. rates become higher (than Korea's), it will definitely put downward pressure on the won's value," expressing concern that "won depreciation will increase Korea's inflation rate." At a briefing after the Monetary Policy Committee meeting, he also said, "Historically, when the gap widened significantly, it fluctuated around 1 percentage point, so I think it is necessary to monitor negative effects to ensure the gap does not become too large."

The market expects the BOK to continue its rate hike trajectory in the first half of next year as the U.S. rate hike trend continues. Park Seok-gil, Head of JP Morgan's Financial Market Operations Department, forecasted, "The BOK will raise rates consecutively by 0.25 percentage points three times this year (August, October, November) and once more in January next year, reaching a benchmark rate of 3.25%."