[Why&Next] D-3 Key Keywords for the Geumtongwi Meeting... Growth Rate, Terminal Interest Rate, Minority Opinion

[Asia Economy Reporter Seo So-jeong] "Attention should be paid more to the Bank of Korea's growth rate forecast for next year than to the base interest rate."

This is the perspective of the financial investment industry regarding the Bank of Korea's Monetary Policy Committee meeting scheduled for the 24th. Currently, the prevailing analysis is that the Bank of Korea will take a baby step (a 0.25 percentage point increase in the base interest rate) at this monetary policy meeting, continuing its sixth consecutive rate hike. Initially, a tight contest between a big step (a 0.50 percentage point increase) and a baby step was expected, but recently, expectations for the U.S. Federal Reserve's (Fed) slowing pace of policy rate hikes have grown, calming the won-dollar exchange rate. The short-term money market tightening caused by the Legoland incident, making financial stability a key task for the Bank of Korea, has also solidified the baby step forecast.

◆Will the 1% range growth rate for next year be formalized?= The revised economic outlook to be announced by the Bank of Korea's Research Department along with the monetary policy decision is becoming the market's biggest focus. The financial investment industry believes that the Bank of Korea can achieve this year's annual growth rate of 2.6%, but expects next year's domestic and external economic conditions to be challenging. Accordingly, many expect the Bank of Korea to lower next year's growth rate to the 1% range, similar to external economic institutions.

The Bank of Korea projected last August that next year's growth rate and consumer price index (CPI) would be 2.1% and 3.7%, respectively. Since last month's monetary policy meeting, it has signaled that it will lower next year's outlook. The key issue is whether the Bank of Korea will officially set next year's growth rate forecast below the potential growth rate (2%) in the 1% range after the monetary policy meeting on the 24th, judging the economy to be in recession. Since the monetary policy committee's decisions are based on the Bank of Korea's economic outlook, they are inevitably closely linked to the final interest rate level.

Kang Min-joo, an economist at ING Bank, said, "The U.S. and Europe's economic growth rates for next year are expected to contract by -0.4% and -0.7%, respectively, and South Korea is expected to show negative growth in the first and second quarters, resulting in an annual growth rate of 0.6%." She added, "The price decline of key export products such as semiconductors, the cumulative effect of interest rate hikes, and high interest burdens are leading to reduced consumption, so the Bank of Korea will take a baby step this month and complete the rate hike cycle with an additional baby step in the first quarter of next year."

◆Will the Monetary Policy Committee unanimously take a ‘baby step’?= Whether the 0.25 percentage point base rate hike will be unanimously decided by the seven members of the Monetary Policy Committee at this meeting is also attracting market attention. Since April, during the five consecutive rate hikes, the only meeting without a unanimous decision was the previous one in October. At the October meeting, which decided on a 0.5 percentage point hike, four of the six committee members, excluding the governor, favored a big step, while two dissented with a baby step.

Currently, three days before the monetary policy meeting, the balance within the Bank of Korea is leaning toward a baby step. At last month's big step decision, committee members Joo Sang-young and Shin Sung-hwan expressed minority opinions favoring a baby step due to concerns about a possible recession. Recently, hawkish members Seo Young-kyung and Park Ki-young have also strongly indicated the need to slow the pace of rate hikes. Bank of Korea Governor Lee Chang-yong also expressed a view supporting a slowdown, stating, "Maintaining financial stability, especially securing stability in the non-bank sector, has become an important issue."

Since many committee members are concerned about the 'money clogging' phenomenon emerging mainly in the corporate bond market, the possibility of a baby step is considered high inside and outside the Bank of Korea. Moreover, a 3-to-3 split between big step and baby step opinions, with the governor casting the deciding vote, would increase market uncertainty and signal a lack of consensus among committee members, which is something the committee internally wants to avoid. Therefore, the possibility of a unanimous baby step is cautiously being raised.

Moon Hong-chul, a researcher at DB Financial Investment, said, "The exchange rate, which was a major reason for last month's big step, has recently stabilized relatively, and the funding shortage situation, especially in the corporate bond market, has not eased, so the Bank of Korea will take a baby step." He added, "Since many loans in South Korea are linked to short-term interest rates, the need to slow the pace compared to advanced countries has increased, and due to concerns about the surge in household debt and the collapse of the real estate market, the Bank of Korea is likely to adjust the magnitude of rate hikes."

In particular, as the global economic slowdown next year leads to a downward revision of South Korea's economic growth rate, voices warning against rapid rate hikes are spreading. The International Financial Center recently predicted, based on analyses from major investment banks (IBs) and the International Monetary Fund (IMF), that next year's global economic growth rate will be only 2.3%. This is the lowest level in 20 years, excluding 2009 (-0.1%) during the global financial crisis and 2020 (-3%) when the COVID-19 pandemic occurred. Accordingly, some expect that there could be minority dovish opinions favoring a freeze due to concerns about the economic slowdown.

◆Widening interest rate gap between Korea and the U.S.= Market interest is also high regarding the final interest rate level that Governor Lee will announce after the monetary policy meeting. Previously, after last month's meeting, Governor Lee stated, "Many committee members seem to have views not significantly different from a final rate level of around 3.5%." Since then, U.S. Fed Chair Jerome Powell said at a press conference following the Federal Open Market Committee (FOMC) meeting earlier this month that "the final rate level will be higher than previously expected," raising the U.S. policy rate peak forecast to the 5% range. Accordingly, the peak of South Korea's base rate is also likely to be revised upward. Currently, major global investment banks forecast the U.S. policy rate peak between at least 4.75% and up to 5.75%, and the market expects the Bank of Korea's final rate to rise to around 3.75%.

The Bank of Korea cited the Fed's tightening intensity, energy prices, won-dollar exchange rate, and domestic financial conditions as key variables influencing next year's monetary policy. On the 17th (local time), James Bullard, President of the Federal Reserve Bank of St. Louis, signaled prolonged tightening by raising the final rate range from 4.75?5.0% to 5.0?5.25%. There are also voices warning against the precedent in the 1970s when rate hikes were paused after inflation briefly stabilized, only for inflation to resurge.

International oil prices are expected to see increased volatility. Oh Jung-seok, a senior fellow at the International Financial Center, forecasted, "The five key factors in the international crude oil market next year are concerns about supply disruptions, shortages of petroleum products, expectations of monetary policy and dollar pivots, crude oil inventory shortages, and geopolitical instability. All these factors will exert upward pressure, potentially pushing oil prices into triple digits by late first half or second half of next year." Domestic financial market tightening is also a major variable. Park Sun-young, a professor of economics at Dongguk University, warned, "All bear markets target the weakest link among countries and companies. With economic bloc formation, tail risks persist, and under sustained high interest rates, attention should be paid to the potential insolvency of small and medium securities firms and construction companies."