[금통위poll]③ "No Meaning in Korea-US Interest Rate Gap vs Burden if Over 1.75%p"

Survey of Securities Firm Analysts and Researchers

The Bank of Korea is expected to keep its base rate unchanged this month, while the U.S. Federal Reserve (Fed) is anticipated to raise rates next month, leading to a wider gap between the Korea-U.S. base rates. Although Lee Chang-yong, Governor of the Bank of Korea, has stated that the widening of the Korea-U.S. base rate gap itself is not significant, concerns have been raised that if the gap exceeds the historic maximum of '1.75 percentage points,' the burden on the Korean economy could increase.

Tense Debate Over Acceptable Korea-U.S. Interest Rate Gap

On the 21st, Asia Economy conducted a survey of 20 analysts from domestic and international securities firms, banks, and economic research institutes. When asked about the "acceptable level of the base rate gap between Korea and the U.S.," 8 respondents (40%) answered that it should be 1.75 percentage points or less. They noted that if the gap widens beyond 1.75 percentage points, the burden on the domestic financial market could increase.

Another 8 respondents (40%) said that there is no fixed acceptable level for the Korea-U.S. interest rate gap. Since there have been no severe side effects such as rapid capital outflows even after the Korea-U.S. base rates reversed last year, they explained that the reversal itself would not significantly impact the market. Additionally, 4 respondents (20%) said that a Korea-U.S. interest rate gap of up to 2 percentage points would be acceptable.

Currently, Korea's base rate stands at 3.5%, while the U.S. rate is between 4.5% and 4.75%. The Bank of Korea's Monetary Policy Committee is likely to keep the base rate unchanged at 3.5% from its meeting on the 23rd, but many analyses suggest that the U.S. Fed will raise rates up to 5.25%, including a 0.25 percentage point hike next month.

If this happens, the Korea-U.S. base rate gap will reach 1.75 percentage points. This exceeds the previous record reversal gap of 1.50 percentage points observed from May to October 2000, marking a level that the Korean economy has never experienced before.

Bank of Korea and Experts: Widening Korea-U.S. Rate Gap Not Significant

Typically, if Korea's base rate remains lower than that of the U.S., side effects such as outflows of foreign investment funds, depreciation of the Korean won, and increased import price burdens due to a rising won-dollar exchange rate may occur.

However, the Bank of Korea and many experts believe that the widening of the Korea-U.S. base rate gap alone will not cause major problems. Governor Lee said at a press conference following the Monetary Policy Committee meeting on the 13th of last month, "If the (Korea-U.S. rate gap) widens excessively, it will naturally have some impact, so we need to be cautious. But it is not appropriate to mechanically consider it risky if it exceeds a certain level," adding, "The direction of U.S. monetary policy has a greater influence on the exchange rate than the interest rate gap."

Park Jung-woo, Chief Economist at Nomura Securities, said, "An appropriate level of (Korea-U.S.) interest rate gap does not exist theoretically or practically," explaining, "The interest rate gap is a meaningful concept for countries with fixed exchange rate systems, but for countries like Korea that adopt a floating exchange rate system and have open capital markets, it is not an appropriate concept."

Kang Min-joo, Chief Economist at ING Seoul Branch, explained, "The (acceptable Korea-U.S.) interest rate gap level can vary depending on economic conditions, so there is no absolute figure," adding, "While additional Fed rate hikes may increase market volatility, it is expected to be a short-term phenomenon."

Jerome Powell, Chairman of the U.S. Federal Reserve (Fed) [Image source=Yonhap News]

Concerns Over Market Burden If Gap Exceeds '1.75 Percentage Points'

However, many also caution against taking the excessive widening of the Korea-U.S. interest rate gap lightly. Yoon Seok-jin, a researcher at Hana Financial Management Research Institute, said, "Key criteria for assessing the burden caused by the widening interest rate gap include the scale of foreign capital outflows and exchange rate volatility," adding, "If the reversal gap exceeds the expected final level of around 1.75 percentage points, it is highly likely to act as a burden on the domestic financial market."

Baek Yoon-min, a researcher at Kyobo Securities, said, "If the Bank of Korea judged the median value of the interest rate dot plot presented at the December Federal Open Market Committee (FOMC) meeting as the final level, it would likely be concerned about the burden of a Korea-U.S. interest rate gap exceeding 1.75 percentage points."

Experts who answered that there is no fixed acceptable Korea-U.S. interest rate gap level also clarified that this applies only under the premise that exchange rate and foreign exchange market stability continue. If the Korea-U.S. interest rate gap widens beyond 1.75 percentage points and financial market instability increases, the Bank of Korea would have no choice but to consider additional rate hikes.

Im Jae-kyun, a researcher at KB Securities, said, "As the Bank of Korea Governor mentioned, there is no estimated acceptable Korea-U.S. base rate gap," adding, "However, if the widening reversal gap causes the won to fluctuate, there is a possibility of additional hikes."

Lee Chang-yong, Governor of the Bank of Korea, is explaining the base interest rate hike at a press briefing held at the Bank of Korea in Jung-gu, Seoul, on the 13th of last month. (Photo by Joint Press Corps)

"Interest Rate Gap Not an Absolute Factor, But Narrowing It Is Appropriate"

Recent U.S. employment data, consumer price inflation, and retail sales exceeding market expectations have raised concerns that the Fed's tightening monetary policy could last longer. According to the Chicago Mercantile Exchange (CME) FedWatch, the market sees a 55% chance that the Fed will raise rates to 5.25-5.50% by June. In this case, the Korea-U.S. interest rate gap could widen to as much as 2 percentage points.

Kim Sung-soo, a researcher at Hanwha Investment & Securities, said, "Past cases confirm that the domestic-foreign interest rate gap does not have an absolutely large impact on the exchange rate or foreign capital inflows and outflows," but emphasized, "However, while the widening interest rate gap is not an 'absolute' factor, it is certainly one of the 'major' factors, and it is appropriate to narrow an excessively wide gap."