[Q&A] Lee Chang-yong "Expectations for Interest Rate Cuts Within the Year Are Excessive... Not the Stage to Mention"

Bank of Korea Holds Base Rate at 3.5% as of 11th
Calls Market's Rate Cut Expectations "Too Excessive"
"Low Possibility of Real Estate PF Crisis Expansion"
"Inflation to Fall to 3%... Uncertainty Remains High"

Lee Chang-yong, Governor of the Bank of Korea, is holding a press conference on April's Monetary Policy Committee interest rate decision at the Bank of Korea in Jung-gu, Seoul on the 11th.
[Image source=Yonhap News]

Lee Chang-yong, Governor of the Bank of Korea, pointed out that five out of six members of the Monetary Policy Committee believe the base interest rate should possibly be raised to 3.75% in the future, and criticized the recent market expectations for rate cuts as being too excessive.

At a press conference held immediately after the Monetary Policy Committee meeting on the 11th, Governor Lee said, "Many committee members think the market's expectations are too excessive," adding, "It seems that both domestic and overseas monetary policy expectations have been pre-reflected, causing the market to overreact."

On that day, the Monetary Policy Committee unanimously decided to keep the base interest rate steady at 3.5% per annum. Governor Lee explained that regarding the final interest rate, one committee member thought it appropriate to maintain the current 3.5%, while the other five members believed the possibility of raising it to 3.75% should be kept open.

Regarding future inflation outlook, Governor Lee anticipated a stable trend with inflation falling to the 3% range from the second quarter onward but noted that uncertainties could be significant due to international oil prices and public utility fee hikes.

On the recent increase in concerns about real estate project financing (PF), he emphasized, "When comparing real estate delinquency rates to the past, they are still at a low level, and internationally, the rates are not absolutely high compared to the rise in interest rates," stressing that the possibility of it escalating into a crisis is low.

Regarding concerns about exchange rates or capital outflows due to the interest rate gap between Korea and the U.S. remaining at about 1.5 percentage points following the Bank of Korea's rate freeze, he said, "The level of the exchange rate itself is not important," and added that since Korea is now a creditor nation, a crisis like in the past will not occur again.

Bank of Korea Governor Lee Chang-yong is presiding over the Monetary Policy Committee meeting held at the Bank of Korea in Jung-gu, Seoul on the 11th.
[Image source=Yonhap News]

Below is a Q&A session with Governor Lee from the press conference.

- What are the final interest rate forecasts of the Monetary Policy Committee members?

▲ Similar to the February Monetary Policy Committee meeting, five members at this meeting expressed the opinion that the possibility of maintaining the final interest rate at 3.75% for the time being should be kept open, while one member thought it appropriate to keep it steady at 3.5%. There are two reasons why the five members want to keep the possibility of a 3.75% increase open. One is the uncertainty about inflation in the second half of the year due to the impact of additional production cuts by oil-producing countries on international oil prices and the timing and extent of public utility fee hikes. The second is the need to observe how the U.S. Federal Reserve (Fed) will conduct monetary policy following the Silicon Valley Bank (SVB) incident.

- With this decision, the interest rate gap between Korea and the U.S. remains at 1.5 percentage points. Considering recent export sluggishness, the won's depreciation could continue for a considerable period.

▲ It is said that the exchange rate depreciation trend will continue due to the trade deficit, but it is unreasonable to expect that as a given. The trade deficit and dividend payments in April have likely already been anticipated and reflected. While the trade balance is an important factor for the exchange rate, how major countries' monetary policies will change, especially whether tightening policies will continue after the SVB incident, will have a significant impact.

- You mentioned that headline inflation will fall to the 3% range from the second quarter, but why is core inflation declining more slowly? Also, why was the core inflation forecast revised upward?

▲ The general consumer price index (CPI) is falling more than core inflation due to a base effect caused by last year's significant rise in energy prices, which have declined this year. Compared to other countries, we raised electricity and gas rates less to reduce the shock to the public, but this year reflects the portion that was not raised last year, so core inflation, which includes electricity and gas rates, is falling more slowly than the general CPI. Also, after social distancing ended, while investment and exports have dropped significantly, consumption is recovering. Service prices are slowing down more slowly compared to other prices. Considering various factors, core inflation is expected to fall more slowly than general CPI, but it is hoped to reach around 3% by the end of the year.

We believe inflation trends will follow our expectations until June this year. We forecast the inflation rate to start with '3' in the second quarter. It is expected to decline in the second half as well, but uncertainties are large. Due to OPEC+'s production cuts, some believe oil prices will rise further, while others think oil prices will not rise significantly because global economic growth forecasts have been downgraded after the SVB incident. The market is in a confused state.

- Governor, you emphasize uncertainty. Does this mean rates must continue to be held steady due to the 'fog'?

▲ Since the February Monetary Policy Committee meeting, some existing uncertainties have become clearer, but new uncertainties such as the SVB incident have emerged. It is still difficult to say that uncertainties have disappeared.

- Why did you say the economic growth forecast for this year (1.6%) might be further downgraded?

▲ The possibility of a slight downgrade in the growth forecast is not unique to Korea. There were expectations that growth in the U.S. and Europe would be better than expected in January and February this year, but the SVB incident suddenly dampened those hopes. A global slowdown in growth is being predicted.

Lee Chang-yong, Governor of the Bank of Korea, is attending a press conference on April's Monetary Policy Committee interest rate decision held at the Bank of Korea in Jung-gu, Seoul on the 11th. [Image source=Yonhap News]

- The market believes rate hikes are over. How do you evaluate this?

▲ Many Monetary Policy Committee members think the market's expectations are too excessive. Five members want to keep open the possibility of further hikes if the inflation path does not follow our expectations, but the market has formed many expectations for rate cuts this year. It seems that both domestic and overseas monetary policy expectations have been pre-reflected, causing the market to overreact.

- Since the Bank of Korea started raising rates before the Fed, could it also cut rates earlier?

▲ It is not the stage to mention the possibility of rate cuts. We need to observe the direction of U.S. monetary policy and then decide.

- A higher exchange rate is good for exports but has the negative effect of raising import prices. Which effect do you think is greater in the current situation? Also, considering trade balance trends, should the exchange rate in the 1300 won range be seen as an appropriate rate rather than a crisis rate?

▲ The level of the exchange rate, whether 1300 won or not, is not important. However, if volatility is high, it needs to be managed. The pros and cons of the exchange rate used to be thought of as depreciation increasing exports but raising prices, but that framework no longer works. The exchange rate's impact on exports and capital markets has both advantages and disadvantages, affecting different groups differently. Especially in the past, when external debt was high, an appreciation of the exchange rate could cause national default, but now we are a creditor nation. When the exchange rate fluctuates, some benefit and some suffer.

- There are opinions that further rate hikes would destabilize both the economy and financial markets.

▲ While rate hikes help control inflation, various side effects may occur. Maintaining financial stability during the process of controlling inflation is also an important policy goal. Recently, the U.S. showed that despite the need to control inflation, liquidity was supplied to maintain financial stability when problems arose. We must pursue both goals simultaneously.

- There are concerns that Korea Electric Power Corporation bonds (KEPCO bonds) are rapidly absorbing market funds, potentially causing liquidity crunches like last year.

▲ Last year, the Legoland incident caused the entire market to stiffen, and combined with the issuance volume of KEPCO bonds, the shock to the market was significant. However, the market is stabilizing now, so KEPCO bonds are not expected to impose as much burden as last year. Still, if KEPCO bonds continue to be issued in large amounts, it could be a burden, so the government is expected to respond by raising electricity rates to some extent.

- Recently, concerns about the Saemaeul Geumgo project financing (PF) insolvency have increased.

▲ There are many concerns about real estate PF, not just Saemaeul Geumgo. However, the decline in real estate prices has slowed significantly. The possibility of a soft landing in the real estate market is greater than last year. Since we started to hold rates steady, we hope concerns about real estate PF will decrease. Compared to the past, real estate delinquency rates are still low, and internationally, they are not absolutely high compared to the rise in interest rates. Financial institutions' capital and loan loss provisions are manageable. Some financial institutions may face difficulties, but our role is to prevent this from spreading to the entire market.

Bank of Korea Governor Lee Chang-yong is holding a press conference on April's Monetary Policy Committee interest rate decision at the Bank of Korea in Jung-gu, Seoul on the 11th.
[Photo by Yonhap News]

- You said the impact of the SVB incident on Korea is limited, but if problems arise in the future, could it have additional effects on Korea?

▲ What everyone agrees on from the SVB incident is that the conflict between the goals of price stability and financial stability is likely to intensify. Also, the possibility of a downward revision of global economic growth has increased. Korea is affected in that regard. However, we believe the direct ripple effects will be limited. In the U.S., fixed-rate loans are more common than variable-rate loans, and securities or bonds held have much longer maturities, so asset prices fall more when interest rates rise. In Korea, variable-rate bonds are more common and bond maturities are shorter than overseas, so the shock is greater on final consumers, i.e., households, than on financial intermediaries. Also, this incident has made us realize how supervision and crisis management should change as digital banking develops.

- The semiconductor sector continues to face difficulties. Do you expect a rebound in the second half?

▲ According to data held by the Bank of Korea, it is difficult to predict semiconductor prices. It is also difficult to say they will not rise in the second half. Excluding semiconductors and IT, Korea's growth forecast is about 1.9% at the current level. We expect the IT sector to recover, but even if it recovers late, if other growth rates are maintained, the market should consider whether this situation requires a monetary policy response.

- The Governor of the Bank of Japan recently changed. The new governor said he would maintain 'Abenomics.' What impact does this have on Korea?

▲ Any economic policy requires gradual rather than abrupt changes. As Governor Kazuo Ueda said at his press conference yesterday, maintaining current policies until wage increases in Japan are established and deflationary pressures are resolved is a good policy. It provides stability to international financial markets in the current state and is a desirable stance for us as well.

- Can we say that this (rate freeze) decision was more influenced by concerns about economic recession than last time, or did newly added financial stability concerns have a greater impact?

▲ Fundamentally, the first priority is price stability, and the second is financial stability. We worry about the economy because a downturn could affect financial stability. While some say a growth rate in the 1% range is historically very low, we must distinguish between cyclical growth and long-term growth. I worry about growth falling below 1% in the long term. Long-term issues must be addressed by reducing dependence on China, creating new products, and structural adjustments. The Bank of Korea always prioritizes price stability. Attempts to change long-term economic growth through monetary and fiscal policy could make the national economy more difficult and should be avoided.