[Q&A] Lee Chang-yong, Governor: "Inflation Will Exceed 2%... Discussing Interest Rate Cuts Is Premature" (Comprehensive)

Price Stability Target Operation Status Briefing

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Bank of Korea Governor Lee Chang-yong is explaining the "Operation Status of the Inflation Stabilization Target for the Second Half of 2022" at the Bank of Korea press room in Jung-gu, Seoul, on the 20th. Photo by Joint Press Corps

Lee Chang-yong, Governor of the Bank of Korea, explained that although the inflation rate next year is expected to show a "high at the beginning and low at the end" trend and gradually decrease, a high inflation rate exceeding the target level of 2% will continue for a considerable period. He emphasized the need to "continue operating monetary policy with a focus on inflation."

Governor Lee made these remarks on the 20th at the ‘Price Stability Target Operation Status Review Briefing’ held at the Bank of Korea headquarters in Jung-gu, Seoul, regarding next year's inflation outlook and monetary policy direction.

He stressed, "We can discuss interest rate cuts when there is evidence that the inflation trend will converge to our target in the medium to long term, but it is still premature," adding, "Price stability is an unchangeable duty of the Bank of Korea."

Below is a Q&A session with Governor Lee.

Bank of Korea Governor Lee Chang-yong is explaining the "2022 Second Half Inflation Target Operation Status" at the Bank of Korea press room in Jung-gu, Seoul, on the 20th. Photo by Joint Press Corps

-At the Monetary Policy Board meeting last November, you mentioned that discussions on interest rate cuts can only happen when there is confidence that inflation has sufficiently stabilized. What are the criteria to make such a judgment?

▲The ‘2%’ target in the inflation targeting system refers to the consumer price inflation rate. However, since the 2% target is to be achieved in the medium to long term, in the short term, decisions are made by considering core inflation and inflation expectations to predict the consumer price inflation trend.

-The December Federal Reserve (Fed) Federal Open Market Committee (FOMC) dot plot suggests interest rate cuts starting in 2024. Could the Bank of Korea cut rates before the Fed?

▲The discussion at the November Monetary Policy Board was that it is still premature to discuss interest rate cuts. Interest rate cuts can be discussed when there is confidence that the inflation trend will converge to our target in the medium to long term. Due to our economic structure, the Fed’s rate decisions significantly impact our foreign exchange market, so we must consider them, but we do not mechanically stop raising rates or raise them further just because of the U.S. rates.

-The briefing materials today seem to emphasize a slowdown in inflation. Does this imply a change in the priority of inflation-focused policy?

▲The Bank of Korea’s policy prioritizing inflation is an unchangeable duty. According to Article 1 of the Bank of Korea Act, price stability must be prioritized for sound national economic development. At the same time, financial stability must be considered. Since the recent inflation trend is slowing down, we plan to implement policies with a focus on price stability while taking this into account.

-The inversion between short- and long-term interest rates is widening, and the market views this as a signal of economic recession.

▲In the U.S., after years of research, an inversion between short- and long-term interest rates is considered an important indicator predicting future recessions, but in Korea, there is still much debate in academia. I believe that the short-term rates that rose recently will soon decline. The recent rate increases were largely due to supply-side factors such as energy, so once supply instability stabilizes, rates will inevitably decline in the long term.

-You mentioned that the increase in electricity rates next year might be larger than the forecast made in November. Should the inflation outlook for next year also be revised upward?

▲When we made the forecast in November, we expected electricity rates to rise next year by the same amount as this year, but now I think it might increase more than that. However, international oil prices are falling significantly compared to previous forecasts, so the decline in oil prices and the increase in electricity rates are expected to offset each other.

-The exchange rate rose abnormally from September to early November, and the Bank of Korea and the government implemented various measures. Now, the risk factors for upward pressure have disappeared. Can we conclude that even if overseas factors re-emerge, there is no risk of instability?

▲The exceptional rise in exchange rates in September and October was due to the Fed’s accelerated rate hikes after Jackson Hole. Globally, the dollar strengthened, and exchange rates depreciated. This was a phenomenon caused by the unilateral rapid pace of U.S. rate hikes.

(However) the likelihood of the U.S. raising rates sharply again has greatly decreased. Domestically and internationally, domestic investors have increased overseas investments. As the exchange rate exceeded 1,400 won, a lot of domestic funds that had gone abroad returned. In that sense, the risk has decreased, but uncertainty remains. Although there may not be rapid exchange rate changes, we need to observe how the trend will change.

-The Bank of Korea has continuously revised upward its consumer price forecasts this year. How do you respond to some evaluations that it failed to properly reflect international oil prices or public utility rate hikes?

▲I humbly accept that the Bank of Korea’s forecasts were continuously revised upward and were not precise enough. However, this year, due to the Ukraine war, energy prices changed rapidly, making predictions difficult. Not only Korea but all countries faced similar difficulties, and I hope this will be considered generously.

[Image source=Yonhap News]

-What role do you think the government should play to stabilize prices?

▲Inflation is influenced by aggregate demand management but also significantly by supply factors such as agricultural products. The government has played a very positive role in managing supply for vegetables and other items, greatly stabilizing prices. I believe that the government showing a tightening stance by reducing the fiscal deficit more next year than this year will greatly help policy consistency and aggregate demand management.

-The Bank of Korea has maintained the stance that the risk of under-response is greater than over-response while continuing rate hikes. You suggested a final rate level of 3.5% next year. Do you think this level eliminates the risk of under-response?

▲At the last meeting, most Monetary Policy Board members thought 3.5% would be the final rate, but this was stated to communicate opinions to the market, not as a commitment or promise that the Bank of Korea will proceed accordingly. If the premise changes, this can also change. Based on November data alone, most board members thought 3.5% would not be under- or over-response.

-You mentioned that the international oil price assumption has fallen significantly compared to last month’s forecast. Does this mean there is a possibility of downward revision in next year’s inflation outlook?

▲International oil prices have fallen compared to the November forecast, but there is great uncertainty about whether this will continue. The biggest uncertainty is the Russia-Ukraine war. When I took office last April, I cautiously said that by October or November, the war would stabilize and settle, but my forecast was completely wrong. If the war drags on longer, it is difficult to predict how oil prices will change.