[Q&A] Lee Chang-yong, Governor: "Uncertain Start to US Interest Rate Cut Discussions" (Summary)

Price Stability Target Operation Status Briefing
"Need to Monitor Whether Market Is Overreacting"
"Price Target Convergence Expected by Late Next Year or Early the Year After"

Lee Chang-yong, Governor of the Bank of Korea, said on the 20th, "There is still uncertainty about whether the United States has started discussions on interest rate cuts."

Governor Lee made this remark during the 'Price Stability Target Operation Status Review Briefing' held at the Bank of Korea headquarters in Jung-gu, Seoul, referring to Federal Reserve Chairman Jerome Powell's dovish (preference for monetary easing) comments at this month's Federal Open Market Committee (FOMC) meeting.

Governor Lee stated, "Chairman Powell's remarks are interpreted not as an intention to immediately change monetary policy but as a sign that maintaining the current monetary policy level for a long time would be quite restrictive," adding, "It seems the market is reacting because there was mention of discussions about rate cuts, but we need to observe whether this is an overreaction."

Lee Chang-yong, Governor of the Bank of Korea, is speaking at the '2023 Second Half Price Stability Target Operation Status Review Briefing' held on the 20th at the Bank of Korea in Jung-gu, Seoul. Photo by Joint Press Corps

Below is a Q&A from the briefing.

- Regarding the timing for inflation to reach the target level, in the October and November Monetary Policy Committee meetings, it was said it would be delayed compared to expectations. Can we say the assumptions now are very different from then?

▲(Kim Woong, Deputy Governor) There are two major changes in conditions since the last forecast. One is international oil prices, which have fallen significantly compared to the previous forecast. The second is the change in expectations for U.S. interest rate cuts. However, recently, inflation has rebounded again, and U.S. monetary policy has been quite volatile. Rather than discussing now, we plan to review conditions and provide an update around January or February next year. Regarding the timing of target convergence, at this point, we expect it to be around the end of next year or the first half of 2025 for Korea.

- The U.S. core inflation rate is 4%, and due to concerns about excessive tightening, discussions on rate cuts have begun. Korea's rate is about 1 percentage point lower, but is it still uncertain whether inflation is converging to the target enough to start rate cut discussions?

▲(Governor Lee Chang-yong) There is uncertainty about whether the U.S. has started discussions on rate cuts. In my view, Chairman Powell's remarks mean that even if rates are not raised further and the current level is maintained for a long time, it would be quite restrictive. During his remarks, the mention that "there were discussions about rate cuts" seems to have led to different market interpretations, but I think we need to wait and see. We should observe whether the market is overreacting. I cautiously speculate that it may not be a formal indication of rate cut discussions.

- It is expected that central banks in various countries will cut rates next year. How will this affect domestic inflation?

▲(Governor) We do not expect major countries' rates to rise further, and in conducting monetary policy, overseas factors have stabilized significantly, allowing us to independently consider domestic conditions. Independence has been strengthened.

(Deputy Governor) There could be two channels of impact. One is that a weaker dollar lowers import prices, exerting downward pressure on inflation. The other is that lower interest rates could raise commodity prices, exerting upward pressure. Theoretically, both exist, but the actual effect depends on the economic situation and intensity. We need to monitor and review the trends.

- This year, the government designated item-specific managers and held meetings with the food industry to strongly manage inflation. Do you think this helped the inflation slowdown trend? If managed inflation later appears as delayed price increases, could it slow the inflation decline?

▲(Governor) Inflation management last year prevented prices from rising significantly. This had a positive effect by influencing expectations. However, as there is no free lunch, the process of reversal could slow the pace of inflation decline.

- The market evaluates that the Fed has strongly shifted to a dovish stance. This has led to comments that there is strong confidence in inflation stabilizing downward next year, and opinions that the Fed is seeing economic risks the market does not. What do you think is the background?

▲(Governor) By mentioning that rate cuts were discussed, the market seems to have viewed it as dovish. I do not think the change is as significant as the market perceives. It is true that the possibility of rate cuts has increased.

- If the Fed eases tightening somewhat prematurely, how would that affect our inflation path?

▲(Governor) With the near certainty that the U.S. will not raise rates further, international financial markets have stabilized significantly. This has removed one constraint in conducting monetary policy, so the message that we can independently consider domestic factors in monetary policy is more important than how it affects inflation.

- At the November Monetary Policy Committee meeting, you spoke to block expectations of rate cuts until the first half of next year. Considering recent Chairman Powell's remarks, can we say there is no change in stance?

▲(Governor) I have not had a chance to discuss with Monetary Policy Committee members since the recent FOMC. Regarding how the FOMC results will affect future monetary policy direction, I plan to speak about it in January next year. Personally, Powell's remarks do not seem as unexpected as the market reaction suggests.

- Although the U.S. core inflation is more than 1 percentage point higher than Korea's, internal discussions on rate cuts have emerged. It seems Korean Monetary Policy Committee members are not in such a situation. If the U.S. really cuts rates three times, could the Bank of Korea's rate cut timing be brought forward?

▲(Choi Chang-ho, Director of Research Department) Interest rate policy decisions are made by considering inflation, economic conditions, and financial stability together. Since last week's U.S. FOMC, market expectations for rate cuts have changed, but volatility is high, so we need to observe how it converges. Regarding inflation expectations, core inflation is 2.9%, consumer inflation 3.3%, and the baseline forecast is that inflation will converge by the end of next year or early 2025. Although inflation expectations are high, if inflation follows our forecast, it should stabilize. However, there is uncertainty about the impact of international oil prices and accumulated cost pressures, so we are monitoring.

(Governor) There are differences in economic structures between the two countries, such as variable versus fixed interest rate structures. Also, how much oil price increases have been reflected in inflation and the speed of decline matter. Although the charts show differences in convergence by the end of next year, they decline similarly. From our perspective, the decline will be slower, so we expect it to fall assuming the current level is maintained.

- Was the November inflation forecast based on assumptions of reversals of electricity and city gas price hikes and fuel tax cuts? If not, what impact would these measures have when implemented?

▲(Director of Research) We basically reflect government announcements. Since the government announced a policy to gradually raise prices reflecting deficits of energy public enterprises, we assumed and incorporated gradual increases. However, specifying timing is difficult as it could be mistaken for prior knowledge of policy. Even if raised all at once, it may not deviate significantly from the path.

- At the last Monetary Policy Committee meeting, you expressed the view that 2% growth is favorable compared to potential growth and advanced countries. If inflation stabilizes as planned, growth and household debt issues may conflict. If growth above 2% is maintained, which should be prioritized: growth or household debt?

▲(Governor) Household debt is a long-term issue to be resolved and is not something to be traded off against growth. When conducting interest rate policy, we need to see if household debt adjustment is hindered in the long term. The growth rate for next year is 2.1%, assuming a strong recovery in IT exports. Internally, excluding IT, domestic demand growth is expected at 1.7%. The perceived economic recovery may vary by sector. Overall economic growth is close to potential growth, so no stimulus is needed, but targeted support for vulnerable groups may be necessary. When setting interest rates, the concern is that if growth slows, the trade-off between the economy and inflation becomes delicate, and we need to consider how to respond. We should be cautious about funds flowing into real estate if rates are lowered.

- The real estate PF (Project Financing) issue has re-emerged among some construction companies. Earlier this year, it was said that a 30% drop from the peak in real estate prices would be risky. Is that standard still valid?

▲(Governor) I cannot comment on individual companies, but since rates have remained high, this is a side effect. We share the view with financial authorities that orderly adjustment is important when PF issues arise. Based on last year's stress tests on financial institutions, a drop of more than 30% in a year would be burdensome. The speed of decline is also important. Last year, prices fell 15%, then rose 5%, and now are adjusting again. We need to re-simulate the 30% figure. Since speed matters, I do not think the number will remain the same. However, views may differ on whether real estate prices will sharply fall like last year. Regardless of price changes, orderly PF adjustment and a soft landing are important policy goals.