[Q&A] Lee Chang-yong "Possibility of Negative Growth in Last Quarter... Precise Monetary Policy Needed"

Bank of Korea Raises Base Interest Rate by 0.25%p... 7 Consecutive Increases

Lee Chang-yong, Governor of the Bank of Korea, is explaining the base interest rate hike at a press conference held on the 13th at the Bank of Korea in Jung-gu, Seoul. The Monetary Policy Committee of the Bank of Korea raised the base interest rate by 0.25 percentage points from 3.25% to 3.50% on the same day. Photo by Joint Press Corps

Lee Chang-yong, Governor of the Bank of Korea, stated that among the Monetary Policy Committee members, three favored holding the final interest rate steady at 3.5%, while the other three were open to raising it to 3.75%. He emphasized that "a sophisticated monetary policy that simultaneously considers inflation, the economy, and financial stability is needed at this time."

Governor Lee explained this during a press conference held after the Monetary Policy Committee's meeting on the 13th. The committee decided to raise the base interest rate by 0.25 percentage points from 3.25% to 3.5%. This marks the first time since April last year that rates have been increased seven consecutive times.

Previously, in a press meeting after the Monetary Policy Committee in November last year, Governor Lee mentioned that three members viewed the final interest rate level as 3.5%, one member believed it should stop at 3.25%, and two members thought there was a need to raise it up to 3.75%.

On this day, Governor Lee explained, "It is premature to talk about lowering interest rates before we have confidence that inflation is definitely converging to our expected level."

Regarding the split opinion among the committee members on the final interest rate, with three members on each side, he said about his own stance, "In a situation with uncertainty, it is not appropriate to take sides, so I did not express an opinion today," adding, "I will share my opinion when it is absolutely necessary."

Governor Lee also said that the domestic economic growth forecast for this year is expected to be lower than the 1.7% predicted in November last year.

He stated, "Looking at various economic indicators released over the past month or so, the possibility of growth being lower than that has increased. However, this is a common phenomenon worldwide, and compared to the recession risks in major countries, we are in a better position."

Below is a Q&A session with Governor Lee.

Lee Chang-yong, Governor of the Bank of Korea, is presiding over the first Monetary Policy Committee meeting of 2023 held at the Bank of Korea in Jung-gu, Seoul on the 13th. Photo by Joint Press Corps

- How has the view on the final interest rate level among Monetary Policy Committee members, announced in November, changed?

▲ The committee's discussion focuses on what the peak base interest rate will be over the next three months. In this meeting, three members thought it would be desirable to observe the rate for a while after reaching a final rate of 3.5%, while the other three suggested keeping open the possibility that the final rate could rise to 3.75% depending on circumstances. These views are based on the currently expected inflation and growth trends, as well as financial and foreign exchange market conditions. This does not constitute a policy commitment to maintain that level.

- In last month's inflation briefing, you mentioned that the economy is on the borderline of recession. Has the possibility of recession increased now?

▲ In November last year, we forecasted a growth rate of 1.7% for this year, but looking at various indicators released over the past month or so, the possibility of growth being lower than that has increased. The fourth-quarter growth rate for last year will be announced in two weeks. During that period, COVID-19 spread widely in China, restricting movement significantly; the semiconductor industry declined further; and various factors such as the Itaewon incident negatively affected economic indicators. There is a high possibility of negative growth in the fourth quarter. However, for the first quarter of this year, we expect early fiscal spending, and although recent data show that the US and Europe are heading toward recession, factors such as warm weather in Europe and a robust US labor market suggest upward revisions in growth forecasts. Considering these, we expect the first quarter to be better than the fourth quarter.

However, considering sluggish exports and global economic slowdown, the first half of this year is expected to be a difficult period. It is premature to call this a recession; we need to observe data at the recession borderline. This is a common phenomenon worldwide, and compared to the recession risks in other major countries, we are in a better situation.

- Can it be interpreted that after this rate hike, the rate will be held steady starting next month?

▲ I don't think it should be interpreted that rates will be held steady from now on. Inflation rates are around 5% in January and February, so monetary policy should focus on inflation for the time being. However, after January and February, inflation is expected to fall below 5% and show a downward trend. Compared to when inflation was above 5%, a more sophisticated monetary policy that simultaneously considers inflation, the economy, and financial stability is necessary.

- Recently, there have been market expectations for rate cuts within the year. Is this irrational?

▲ It is premature to talk about rate cuts before we have confidence that inflation is definitely converging to our expected level. Since there are both upside and downside risks to inflation, it is appropriate to discuss rate cuts only when data confirm that inflation will reach our target level in the medium to long term.

- In October last year, when the won-dollar exchange rate exceeded 1,400 won, you advised that overseas investment strategies should be like when the rate was in the 1,200 won range to avoid buying at the peak. Does that advice still hold when the exchange rate is now in the mid-1,200 won range?

▲ The comments about the exchange rate at that time were exceptional because in September and October last year, the exchange rate showed an extreme skew and excessive depreciation, which could be identified regardless of economic theory. Except in cases of extreme skew, it is not appropriate for the central bank governor to comment on market prices.

- You said that rate cuts would be discussed only when there is confidence that inflation will converge in the medium to long term. If such a situation arises, could Korea cut rates ahead of the US Federal Reserve?

▲ Our rate decisions prioritize domestic conditions. However, we also consider concerns about financial stability that may arise when the interest rate gap widens significantly due to the US's continued rate hikes. Fundamentally, conditions are in place to make rate decisions based on domestic circumstances.

- Despite the Bank of Korea's rate hikes, the Korea-US interest rate gap is 100 basis points (1bp=0.01%p). How do you view this? What do you consider an appropriate range?

▲ Capital movement between the two countries is not determined solely by interest rate differentials unless there is a fixed exchange rate system. Past experiences are only references. While excessive gaps can have an impact and should be monitored, there is no theoretical basis that 100bp is risky and 150bp is very risky. The effect of interest rate differentials on exchange rates is limited. It is not advisable to judge mechanically.

- You hinted at revising the economic growth forecast within less than two months. What major assumptions have changed?

▲ The biggest change in December was the Chinese economy. We expected the zero-COVID policy to be gradually relaxed, but it was suddenly eased, leading to a short-term increase in cases and a worse-than-expected short-term economic situation in China, which significantly reduced our exports. Also, our exports to advanced countries declined at year-end, causing significant changes. Domestically, consumption decreased more than expected, and combined with the Itaewon incident and labor market issues, December indicators were poor. These need to be mechanically adjusted.

- The committee is split 3 to 3 on the final interest rate. What is your personal view?

▲ When we raised rates by 25bp this time, the decision was 4 to 2, so I did not need to intervene. Since future rates are forecasts with uncertainty, I thought it inappropriate to take sides by expressing my opinion, so I did not. I will share my opinion when decision-making is absolutely necessary.

Lee Chang-yong, Governor of the Bank of Korea, is presiding over the first Monetary Policy Committee meeting of 2023 held at the Bank of Korea in Jung-gu, Seoul on the 13th. Photo by Joint Press Corps

- You said it is premature to discuss rate cuts this year. If the outlook path continues, do you see no need for rate cuts?

▲ I cannot speak in principle. If inflation and growth follow the paths we expect this year, we will leave rates as they are. But if inflation rises beyond that, rates will need to be adjusted upward, and if growth falls faster, we will have to consider that as well.

In principle, since we prioritize inflation, it is difficult to cut rates without evidence that inflation will reach our target level in the medium to long term. In the central banking community, it is believed that once inflation exceeds 5%, expectations can be stimulated, accelerating inflation.

- The most unstable part of the domestic economy this year is real estate. Recent real estate slowdown is seen by some as normalization of an excessive bubble. If real estate problems further slow the economy, do you think policy response through interest rates is necessary?

▲ The real estate market is certainly a factor undermining financial stability, but it concerns one sector. Interest rates affect overall effective demand. Real estate market policies should primarily be addressed through fiscal policy. While rate hikes have exacerbated difficulties in the real estate market, in some ways, they have normalized excessive leverage and the previously high real estate prices. For a soft landing in the real estate market, regulation and fiscal policy should take priority, and even if the Bank of Korea acts, it should be through partial liquidity supply rather than interest rate adjustments, which are not advisable.

- You said the economic growth forecast is lower than the previous 1.7%, but inflation aligns with the previous forecast. Why is that?

▲ Although the economy is expected to be downgraded, inflation is maintained at the forecasted 3.6% because there are offsetting factors. One is that the economy lowers inflation, and oil prices have fallen. On the other hand, public utility fees are rising. Also, if the Chinese economy improves in the second half, oil prices may rise overall. Considering these, we kept 3.6% unchanged.

- You said inflation will reach the target level in the medium to long term. What is the approximate period? If inflation does not stabilize after that period, would you consider adjusting the inflation target?

▲ We expect inflation to remain around 5% in January and February and to approach about 3% by year-end, followed by a further decline. Compared to the US and Europe, we perceive that inflation is converging to our target faster.

Many ask if we would raise the inflation target from 2% to 3% if inflation declines more slowly than expected. That would be the worst approach. Changing the target would alter inflation expectations, so target adjustments should be made only after inflation stabilizes and for other reasons. If inflation does not converge to our target as expected, rate adjustments will be necessary.

- Recently, the government has eased real estate loan regulations significantly. While aimed at market stabilization, some say it signals 'borrow to buy a house.' The Bank of Korea must manage inflation and household debt. How do you view the government's pace and timing of easing real estate regulations?

▲ I think the government's announcements also aim to resolve side effects caused by excessive regulations or tax measures intended to curb real estate prices. I believe there is a risk that easing regulations will increase real estate loans, but since the real estate market is in a downturn, the likelihood of a large-scale increase in real estate loans due to eased regulations is low. Also, the DSR regulation remains, so while mortgage loans may increase, a rapid rise in household debt or real estate loans is limited.

Of course, if the economy enters a recovery phase, loans may increase, but that is not now. That should be addressed not by regulations but by well-designed macro policies. When that time comes, it is very important for authorities to seriously plan and implement macroprudential policies differently from before to prevent repeating mistakes of rapid increases in real estate loans and household debt.

Lee Chang-yong, Governor of the Bank of Korea, is striking the gavel at the first Monetary Policy Committee meeting of 2023 held at the Bank of Korea in Jung-gu, Seoul on the 13th. Photo by Joint Press Corps