[금통위poll]③ The Bank of Korea's Biggest Concerns Are 'International Oil Prices and Household Debt'... Risk of Missing Both Inflation and Economic Growth

Survey of 22 Market and Economic Experts
Key Variable in Monetary Policy: International Oil Prices
High Interest Rates and Inflation... Concerns Over Stagflation
Due to High Uncertainty, Bank of Korea Temporarily Holds Rates

Following production cuts by oil-producing countries including Saudi Arabia, and the outbreak of war between Israel and the Palestinian armed group Hamas, international oil prices have emerged as the biggest variable in the Bank of Korea's monetary policy. If the rise in international oil prices increases inflationary pressure, both the US and South Korea will have no choice but to maintain a high interest rate stance for a longer period, which, combined with South Korea's high household debt ratio and sluggish export situation, is feared to further slow economic recovery. Among experts, amid growing economic uncertainty stemming from the Middle East, there are even forecasts that the Bank of Korea and the government could fail in managing both inflation and the economy, leading to 'stagflation' (economic stagnation amid high inflation).

According to a survey conducted by Asia Economy on the 16th targeting 22 domestic and international securities analysts and economists from economic research institutes, a significant number of experts identified inflation instability due to rising international oil prices, US monetary policy, and household debt as the key variables (multiple answers allowed) for the Bank of Korea's future monetary policy. As in the survey conducted before the Monetary Policy Committee meeting in August, international oil prices were cited by 9 respondents as the most important, followed by household debt and US monetary policy with 7 each, and the Israel-Hamas war with 4.

From Production Cuts to War... High Interest Rates to Continue if International Oil Prices Surge

Experts foresee that the rise in international oil prices will be the most important variable in determining the Bank of Korea's monetary policy direction going forward. Since mid-year, production cuts by Saudi Arabia and Russia have increased upward pressure on oil prices, and recently, the Israel-Hamas war has further destabilized the Middle East situation, deepening uncertainty. International oil prices soared to $93-$94 per barrel on the 27th of last month, then slightly dropped to the $80 range, before rising again above $90 last week. The securities industry expects that if this armed conflict escalates into a full-scale Middle East war, oil prices could exceed $100 per barrel.

When international oil prices rise, inflationary pressure increases in major countries including the US and South Korea. This can be a factor in maintaining central banks' tight monetary policies. South Korea's consumer price inflation rate (year-on-year) fell to 2.3% in July but increased to 3.4% in August and 3.7% in September as international oil prices rose.

Yoon Seok-jin, a researcher at Hana Financial Management Research Institute, said, "(The Middle East situation) involves high uncertainty due to possible involvement of other countries or escalation, so it is necessary to closely monitor future directions," adding, "In particular, if international relations between the US and the Middle East deteriorate, there are concerns about the negative inflationary impact caused by oil price instability, which risks changing the monetary policy conditions of major countries." Kim Sun-tae, an economist at KB Kookmin Bank, also said, "The key variables determining import price trends are international oil prices and the won-dollar exchange rate."

The Bank of Korea is also closely watching international oil price trends. On the 12th (local time), at the G20 Finance Ministers and Central Bank Governors meeting held in Marrakech, Morocco, Bank of Korea Governor Lee Chang-yong told reporters, "There is great uncertainty about how oil prices will move in the future," adding, "For the Bank of Korea, the critical issue is whether core inflation will follow the expected path or rise higher when oil prices fluctuate."

Israeli military M109 155mm self-propelled howitzer fires shells near the border of the Gaza Strip in the south on the 12th (local time). [Image source=Yonhap News]

Rising Household Debt... Bank of Korea May Delay Interest Rate Cuts

Household debt, which has recently surged again, is also a factor constraining the Bank of Korea's monetary policy. According to the Bank for International Settlements (BIS), South Korea's household debt-to-GDP ratio in the fourth quarter of last year was 105%, the highest increase rate globally. Household debt showed signs of slowing due to the Bank of Korea's sharp base rate hikes last year, but surged again early this year due to government loan regulation easing, the introduction of special home mortgage loans, and expectations of a housing price rebound, effectively failing in deleveraging (debt reduction).

The Bank of Korea aims to reduce the household debt-to-GDP ratio below 100%, so it is unlikely to ease interest rates easily amid a rapid increase in household debt. Woo Hye-young, a researcher at Ebest Investment & Securities, said, "Deleveraging of household loans is delayed despite tight financial conditions," and predicted, "The Bank of Korea needs to closely manage to prevent the household debt-to-GDP ratio from rising, so it will maintain a tight stance for some time." An Ye-ha, a researcher at Kiwoom Securities, also explained, "Household debt can limit the extent of the Bank of Korea's interest rate cuts."

[Image source=Yonhap News]

High Interest Rates + Household Debt = Economic Contraction... Is 'Stagflation' Coming?

If the war between Israel and Hamas intensifies global inflationary pressure and prolongs the high interest rate stance, the increased household debt could lead to higher interest burdens, weakened private consumption, domestic demand contraction, and sluggish investment, potentially causing an economic recession. Already, concerns about stagflation?economic stagnation amid rising inflation?are emerging among the International Monetary Fund (IMF) and scholars. In its recently released October World Economic Outlook, the IMF lowered its global economic growth forecast for next year to 2.9%, down 0.1 percentage points, and raised the global inflation forecast to 5.8%, up 0.6 percentage points.

Professor Nouriel Roubini of New York University, who predicted the 2008 global financial crisis scenario, said in a Bloomberg interview on the 12th (local time), "If this war escalates, stagflation could occur," adding, "It will be a huge dilemma for central banks." This points to the possibility that central banks may fail to stabilize inflation and restore economic growth amid uncertainty. Kim Sang-hoon, a researcher at Hana Securities, explained, "The sharp rise in international oil prices due to escalation could be the biggest variable, which expands stagflation concerns."

Bank of Korea Governor Lee Chang-yong is presiding over the second half financial council at the Bank of Korea in Jung-gu, Seoul, on the afternoon of the 25th of last month.
[Image source=Yonhap News]

Financial Instability Could Lead to Rate Cuts... Complex Situation for Bank of Korea, Holding Rates for Now

Additionally, risks related to real estate project financing (PF) and resulting non-bank financial company insolvencies could also complicate the Bank of Korea's monetary policy. Compared to the 'Legoland incident' in Chuncheon last September, the financial market situation has improved, but the possibility of a chain default in real estate PF due to the global tightening stance remains. International credit rating agency Moody's pointed out in a press release at the end of last month that the proportion of PF loans overdue by more than one month among Korean securities firms surged to 17.3% as of June this year, warning of increased risks to financial institutions' asset soundness. Despite high household debt and inflationary pressure, it is not easy for the Bank of Korea to maintain high interest rates for a long time.

The Bank of Korea is expected to maintain its base rate at the current level for the time being while keeping the door open for further rate hikes. Given the many variables such as international oil prices, household debt, the Israel-Hamas war, and real estate PF, the Bank of Korea faces difficulty in either raising or lowering rates and is expected to maintain the current high interest rate level at least until the first half of next year. Kim Ji-na, a researcher at Eugene Investment & Securities, explained, "Events that stimulate oil prices, such as the war, can continuously fuel inflation, so while additional base rate hikes may be difficult, rate cuts could be delayed."