[BOK Focus] Despite SVB and CS Shocks... Central Bank Focuses on Core Inflation

ECB's Independent Move... Bank of Korea Also Contemplates Monetary Policy

"Christine Lagarde, President of the European Central Bank (ECB), delivered a well-crafted and cautious statement." (Mohamed El-Erian, Chief Economic Advisor at Allianz)

Mohamed El-Erian, Chief Economic Advisor at Allianz and former CEO of PIMCO, the world's largest bond management firm, shared his perspective on the ECB's decision to implement a 'big step' (a 0.50 percentage point increase in the benchmark interest rate) on the 16th (local time), despite the shocks to financial markets caused by the bankruptcy of the U.S. Silicon Valley Bank (SVB) and the global investment bank Credit Suisse (CS). Amid heightened financial market uncertainty due to the SVB and CS incidents, some expected the ECB to reduce the size of the rate hike, but the ECB maintained the big step as announced. El-Erian praised Lagarde's communication approach on Twitter, stating, "President Lagarde's statement was balanced, neither leaning towards price stability nor financial stability," commending the cautious communication style.

The ECB stated in its monetary policy guidance that "the inflation rate is expected to remain at a high level for an excessively long period, and the rate hike was decided to return inflation to the medium-term target of 2% in a timely manner." President Lagarde added, "We are monitoring the current financial market tensions," and dismissed concerns by saying, "Price stability and financial stability are not mutually exclusive." She demonstrated her stance as an inflation fighter by affirming, "We will firmly combat inflation," while showing prudence by refraining from commenting on the future path of rate hikes amid growing uncertainty in recent financial conditions, thereby enhancing trust in the central bank. Lagarde also addressed concerns about the SVB and CS ripple effects, stating, "The banking sector is overall much stronger than during the 2008 global financial crisis." As the ECB pursues an independent course, there is speculation that central banks in various countries may adopt their own survival-driven monetary policies depending on the situation.

[Image source=Reuters Yonhap News]

The unexpected SVB and CS incidents have shaken the global financial markets, putting central banks worldwide to another test. While the ECB proceeded with the big step despite the SVB and CS events, the market is closely watching what decision the U.S. Federal Reserve (Fed) will make at the March Federal Open Market Committee (FOMC) meeting scheduled for the 21st-22nd. With the rapid changes caused by successive unforeseen variables, market forecasts are fluctuating constantly. According to the Chicago Mercantile Exchange (CME) FedWatch, expectations that the Fed would hold rates steady recently surged but then eased, standing at 16.6% as of 3 a.m. that day, while a 0.25 percentage point rate hike remains dominant at 83.4%.

Inflation, Employment, Real Estate, and Financial Conditions Differ by Country... Core Inflation Remains High

[Image source=Yonhap News]

Central banks in various countries face different situations regarding inflation, employment, and real estate markets, and with the new SVB and CS variables added, they are expressing difficulties in making monetary policy decisions. On the previous day, Park Ki-young, a member of the Monetary Policy Committee at the Bank of Korea, said, "If making monetary policy decisions over the past year and a half was like solving a fifth-degree equation, it feels like solving an eighth-degree equation in the past week," adding, "Now that the SVB incident has spread to the CS incident, it seems necessary to observe market conditions further."

Although inflation shows signs of slowing, one of the biggest concerns for major central banks is that core inflation (excluding energy and food), which reflects the underlying trend of prices, is not easily falling. The Eurozone's inflation rate in February was 8.5%, slightly down from 8.6% the previous month, but the core inflation rate rose to 5.6% from 5.3%, marking the highest level since the introduction of the euro. Europe's core inflation continues to rise, seemingly influenced with a lag by last year's energy issues. Even though it is a supply-side shock, the persistent rise in core inflation is interpreted as the ECB's determination to curb it by maintaining the big step.

In the U.S., the Consumer Price Index (CPI) in February rose 6.0% year-on-year, down from 6.4% the previous month, but the core CPI, excluding volatile energy and food prices, increased by 0.5% month-on-month, expanding the rise. Housing costs, including rent, have driven core inflation, with housing expenses accounting for more than 60% of the core CPI increase.

In South Korea, core inflation is also not easily subdued. Although the inflation rate in February slowed to 4.8%, falling into the 4% range for the first time in 10 months, the core inflation index, excluding food and energy, rose by 4.0%, maintaining a high level. Park said, "I expect inflation to slow significantly in March, but that is due to base effects," expressing concern that "this does not indicate a change in the trend." He added, "The drop in CPI is good news, but we need to see the March data as well," and mentioned, "Core inflation may be more important for the time being."

Choi Chang-ho, Director of the Research Department at the Bank of Korea, said, "Overall, the inflation trend is slowing," but added, "However, core inflation remains high, there are accumulated cost pressures, and there is also pressure for public utility rate increases, so we need to watch the future trend." Another market official noted, "Among major countries, central banks in South Korea and Canada were the first to pause rate hikes," and predicted, "With the significant impact of the SVB and CS incidents and differences in the soundness of the banking sectors by country, monetary policy differentiation may become more pronounced."