[Q&A] Lee Chang-yong: "No Appropriate Level for Korea-US Interest Rate Gap... Decision Made While Monitoring Inflation"

Bank of Korea Monetary Policy Committee Holds Base Rate at 3.5%
Economic Growth Forecast for This Year Revised from 1.7% to 1.6%
Inflation Rate Forecast Adjusted from 3.6% to 3.5%

Lee Chang-yong, Governor of the Bank of Korea, said on the 23rd, "Five of the Monetary Policy Committee members expressed the opinion that the possibility of the terminal interest rate rising to 3.75% should be kept open for the time being." Although the Monetary Policy Committee decided to keep the base rate at 3.5% on the day, he emphasized that this should not be interpreted as the end of the rate hike cycle.

At a press conference immediately after the Monetary Policy Committee's monetary policy direction meeting, Governor Lee said, "We expect the inflation rate to decrease from the 5% range to the 3% range by the end of the year, but there are many uncertainties involved," adding, "If the inflation path we anticipate changes, we have left open the possibility of raising the base rate further."

Governor Lee reiterated that the widening interest rate gap between Korea and the U.S. does not carry significant meaning. He said, "Under the floating exchange rate system, there is no appropriate level for the Korea-U.S. interest rate gap," and added, "While the interest rate gap is one of the important factors, it is not mechanically dangerous if it exceeds a certain percentage."

Regarding the possibility of a rate cut within the year, he said, "We will discuss it if we are confident that the inflation path will reach the target level of 2% as expected," but added, "It is still premature."

Lee Chang-yong, Governor of the Bank of Korea, is striking the gavel at the regular Monetary Policy Committee meeting held at the Bank of Korea in Jung-gu, Seoul on the 23rd. Photo by Joint Press Corps

How do you view the current situation where the Korean won has reached 1,300 won per dollar? Do you think the possibility of it falling to the 1,400 won range, like last October, is low?

The impact of the exchange rate on the inflation path is one of the important considerations, but we do not assign significance to a specific level, whether it is 1,300 won or 1,400 won. The current exchange rate fluctuations are more due to uncertainties about the terminal interest rate and its duration in U.S. monetary policy rather than domestic factors. Rather than targeting a specific level, if there is a concentration or increased volatility in the exchange rate amid uncertainties, we will consider measures to maintain financial market stability and inflation control.

There are talks that the U.S. Federal Reserve (Fed) might take a 'big step' (a 0.50 percentage point rate hike) in March. With the Bank of Korea's decision to keep the base rate steady, the interest rate gap between Korea and the U.S. could widen further. What do you consider an appropriate level? If the won depreciates further, domestic inflationary pressures could intensify.

Under the floating exchange rate system, there is no specific appropriate level. If the (Korea-U.S.) gap widens too much, it could be a factor in increasing volatility, which we consider. In that process, if the monetary policy differences between Korea and the U.S. widen, our task is to carefully decide monetary policy by considering whether to tolerate some exchange rate fluctuations, use foreign exchange reserves to prevent concentration, or raise interest rates. The Korea-U.S. interest rate gap is an important factor but it is not mechanically dangerous if it exceeds a certain percentage.

Among the Monetary Policy Committee members who supported the rate freeze this time, was there any opinion that the terminal rate should be raised above 3.75%? If so, please explain the background for advocating a higher terminal rate.

Regarding the terminal rate, one member said it is appropriate to keep it at 3.5% for now, while the other five expressed the opinion that the possibility of raising the terminal rate to 3.75% should be kept open for the time being. Therefore, I said that this freeze does not mean the end of the rate hike trend, but rather that we will consider over time whether additional hikes are necessary.

I have seen various news reports saying that the Bank of Korea froze rates due to increasing economic uncertainty and recession concerns, but that is not the case. In February, the inflation rate is expected to be around 5%, slightly lower than in January, and from March it will drop further to the 4% range. We expect this trend to continue, bringing inflation down to the low 3% range by the end of this year. Since we are on the path we anticipate, we decided to observe the effects before making further rate decisions. It is not that we froze rates sacrificing inflation control because the recession is worsening.

Lee Chang-yong, Governor of the Bank of Korea, is striking the gavel at the regular Monetary Policy Committee meeting held at the Bank of Korea in Jung-gu, Seoul on the 23rd. Photo by Joint Press Corps

The monetary policy statement added the phrase 'for a considerable period' to indicate maintaining a tightening stance. Does this mean there will be no 'pivot' (policy direction change) within the year like the Fed?

The phrase 'for a considerable period' means that if we become confident that the inflation path is heading toward the policy target of 2%, we will consider rate cuts, but if the path changes or confidence is lacking, adjustments can be made at any time. Please do not interpret 'considerable period' as six months. If inflation aligns with expectations, we will discuss the possibility of rate cuts then; before that, it is premature.

Looking at producer prices and recent inflation expectations, public utility rates are increasing inflationary pressures. Despite this, why was the inflation forecast lowered by 0.1 percentage points compared to three months ago in today's revised outlook?

The biggest reason for lowering the inflation forecast this time is that international oil prices were much lower than expected in November last year. In November, we expected an average of about $93 per barrel this year, but the current forecast is $84?85. However, with China's reopening, there is much discussion about the possibility of global oil prices rising, but this factor is not yet reflected in the oil futures market. Public utility rates are expected to rise about the same as last year and have been preemptively factored in, but if actual government policies are announced, we will need to revise our estimates.

Recently, due to financial authorities' demands, competition to lower banks' deposit and loan interest rates has intensified. Do you think the effect of the Bank of Korea raising the base rate to 3.5% might be limited?

With recent market interest rates falling significantly, some might think monetary policy is ineffective, but as the Bank of Korea raised the base rate by 300 basis points (1bp = 0.01 percentage point), companies and households have felt the higher rates directly. In that sense, monetary policy is working well. The decline in deposit and loan rates is partly an adjustment from the fact that deposit and loan interest rates rose more than the base rate increases in November and December last year.

Today, the consumer price inflation forecast was lowered by 0.1 percentage points, yet the possibility of additional rate hikes was kept open. This seems contradictory.

I do not think so. Looking at the trend, we expect inflation to fall from 5% to 3%, but there are many uncertainties. Rather than deciding to keep rates steady or cut them, we have left open the possibility of raising rates further if the inflation path we anticipate changes due to these uncertainties. All policies are adjusted based on data.

Recently, inflation has picked up again, especially core inflation showing a notable upward trend. If consumer prices and core inflation show different trends, how will the Bank of Korea respond?

There were many differing opinions among Monetary Policy Committee members about core inflation. Core inflation tends to change more slowly than consumer prices. We believe that even if consumer prices fall, core inflation will initially decline slowly, then fall faster if consumer prices drop more significantly as expected. Unlike the U.S., service price inflation is decreasing significantly here. Also, housing prices have fallen considerably, which we expect to have a lowering effect on core inflation. On the other hand, if public utility rates rise, secondary effects may prevent core inflation from falling quickly. Therefore, there is much uncertainty.

You predicted that China's reopening would have a positive effect on our economy, but recently there are forecasts that the effect might be less than expected.

The upward revision of China's economic growth is undoubtedly positive for South Korea. However, there are political and economic uncertainties such as the semiconductor 'Chip 4' alliance with the U.S. Also, if China's recovery focuses on consumer goods rather than investment goods, we, as suppliers of intermediate goods, may not see the same effects as before. In the past, a 1% increase in China's economy was estimated to raise South Korea's growth by about 0.2?0.25%, but internally we now conservatively expect about half that effect. However, if Chinese tourists increase, the positive effect could be greater. If China's recovery pushes international energy prices up, that could be negative for us. We need to monitor this closely beyond the second quarter.

You said the rate freeze decision was to review the inflation path. Why now? Also, last year you said the Bank of Korea is not independent from the Fed. Does this decision contradict that stance?

We chose to freeze rates now because monetary policy is forward-looking. In the second half of last year, inflation was continuously rising, so regardless of review, rate hikes were necessary. But now, since we expect inflation to fall significantly after March, we thought it better to observe rates at this level. Regarding independence from the Fed, last year we wanted to conduct monetary policy based on our inflation path, but the exchange rate variable came in. The U.S. tightened unexpectedly fast, forcing us into a situation where we were not independent from the Fed and had to follow. Unlike last year, now we focus mainly on domestic factors and the inflation path for monetary policy.

Lee Chang-yong, Governor of the Bank of Korea, is attending the regular meeting of the Monetary Policy Committee held at the Bank of Korea in Jung-gu, Seoul on the 23rd. Photo by Joint Press Corps

With the inflation forecast lowered, more Monetary Policy Committee members want to keep the terminal rate open up to 3.75%. Does this mean the upside risk to inflation is greater?

It is correct to say there is upside risk to inflation. Along with that, we need to watch what happens if the interest rate gap with the U.S. widens too much. Considering these factors together, the committee members thought it better to keep the forecast open to 3.75%. If you are driving in dense fog, you stop and wait until the fog clears before proceeding. I hope you understand it with that analogy.

The monetary policy meeting dates have changed too frequently, causing dissatisfaction in the market. What measures are you considering regarding this?

My busy schedule is due to G20 meetings and IMF regular meetings. Currently, changing the meeting date three months in advance causes problems, but going forward, we plan to announce dates one year in advance. Then, whether it is better for me to skip international meetings like the G20 to attend monetary policy meetings is for you to judge. I believe that when the Bank of Korea Governor speaks abroad, overseas institutions listen and it influences international financial markets. Depending on what kind of governor people want, some may prefer international meeting attendance.

Among major countries that have been continuously raising interest rates, Korea seems to be the first to take a freeze action. Did you feel any burden about this?

Canada had said it was considering a freeze. We started rate hikes first and also froze rates almost first, so there was psychological pressure. But since the exchange rate is stable, we feel relieved. However, we do not think we are a capable central bank just because we froze rates earlier than others. We adjusted rate policy according to Korea's specific circumstances.

You said you would discuss rate cuts if confident inflation reaches the 2% target. What do you think about experts' opinions that rate cuts will happen this year?

I will pass on the question of whether rate cuts can be discussed this year. There are uncertainties including core inflation. It does not seem conditions will change that much in a few months.

Besides public utility rates, inflationary pressures are rising on soju, beer, hamburgers, etc. Do you think this is influenced by falling loan and market interest rates?

In January, overseas bond funds withdrew over $5 billion, a record amount. Do you think this is unrelated to the Korea-U.S. interest rate gap?

It is difficult to be certain. Many of the institutions that withdrew bonds were government-managed foreign exchange reserves. It is hard to say whether they withdrew funds to replenish reserves used in foreign exchange market interventions or because of the interest rate gap. In January, the exchange rate depreciated significantly, reducing incentives to invest domestically. We need to observe how these factors interact. Currently, movements seem more influenced by overseas factors than domestic ones.