Bank of Korea's Report on Evaluation and Implications of the US Economic Situation After Interest Rate Hikes
Financial instability, including the bankruptcy of Silicon Valley Bank (SVB) in the United States, is estimated to reduce the U.S. growth rate by 0.2 to 0.5 percentage points this year. On the other hand, under a scenario where global financial instability is resolved in the future and the economic recovery of the U.S. and China strengthens, it is forecasted that the U.S. policy interest rate could rise to a maximum of 5.75% by the end of this year.
On the 12th, the Bank of Korea (BOK) announced in its BOK Issue Note report titled "Assessment of the U.S. Economic Situation After Interest Rate Hikes and Implications" that it set scenarios related to the extent of financial instability spread and the U.S. Federal Reserve (Fed) monetary policy, and examined the ripple effects, resulting in this analysis.
The BOK first set a basic scenario where financial instability would continue for some time, mainly among small and medium-sized banks following the SVB incident, but thanks to the Fed's liquidity supply policy, it would not lead to an overall credit contraction in the financial system. In this scenario, credit supply contraction centered on some problematic banks was found to reduce the U.S. growth rate by 0.2 percentage points this year.
The second scenario assumed that financial instability would spread to other sectors including small and medium-sized banks, worsening global funding conditions and partially transferring to the real economy. Specifically, it was assumed that the U.S. bond credit spread would widen up to 0.7 percentage points in the second quarter of this year before stabilizing by the end of the year. In this case, the overall credit tightening and increased uncertainty due to the spread of financial instability are expected to shrink consumption and investment, lowering the U.S. growth rate by 0.5 percentage points this year.
The third scenario envisions a situation where financial instability is largely resolved, the economic recovery of the U.S. and China strengthens, international oil prices rise further, and global inflation remains at a higher-than-expected level, leading to a further strengthening of the Fed's tightening policy stance. In this scenario, the KRW-USD exchange rate is expected to rise due to expectations of widening domestic and foreign interest rate differentials, and the strengthening of the dollar is anticipated to worsen foreign currency funding conditions for Korean companies. In this case, the credit tightening effect due to financial instability is limited, but the expansion of the Fed's tightening stance due to persistent inflation is expected to reduce the U.S. growth rate by 0.2 percentage points this year, accompanied by a strengthening of the tightening stance by major central banks.
Park Dong-hyun, head of the Model Forecasting Team at the BOK Economic Modeling Department, said, "In the third scenario, the tightening stance will continue in the first half of this year, with the U.S. policy interest rate rising to 5.5 to 5.75% by the end of the year." He added, "If the recovery of China's oil demand and OPEC+ production cuts have a greater-than-expected impact, leading to further increases in international oil prices, upward pressure on inflation may expand, and in this case, central banks including Korea's are expected to strengthen their tightening stances together."
Song Byung-ho, deputy head of the Survey General Team at the BOK Research Department, emphasized, "U.S. financial instability is estimated to reduce the U.S. growth rate by 0.2 to 0.5 percentage points this year depending on the degree of credit supply contraction and the Fed's policy stance." He added, "The decline in U.S. growth will act as a downside risk to global and domestic growth, and especially if financial instability spreads or the Fed re-strengthens its tightening stance, it could negatively affect our growth, inflation, and foreign exchange and financial markets."
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