[Q&A] Lee Chang-yong "Lower Need for Additional Rate Hikes... Too Early to Predict Rate Cuts"

Lee Chang-yong, Governor of the Bank of Korea, stated that the necessity for an additional base interest rate hike has decreased compared to before, but it is difficult to predict a rate cut within the next six months.

At a press conference held immediately after the Monetary Policy Committee's decision to keep the base interest rate unchanged for the eighth consecutive time (at 3.5% per annum) on the 11th, Governor Lee explained, "The risk related to external economic uncertainties such as the possibility of rising oil prices and the Israel-Hamas conflict has eased, significantly lowering the need for further rate hikes," but he added that it is premature to predict a rate cut.

Regarding the real estate project financing (PF) issue related to Taeyoung Construction, he firmly stated that there is no need for the central bank to intervene yet. Governor Lee said, "If adjustments are made in an orderly manner without systemic risk, there is no need for the Bank of Korea to step in," adding, "It is a case of poor risk management, and because it is an important construction company, it has attracted attention."

On household debt, he said, "In the medium to long term, it should be reduced to below 90% of GDP," and added, "Based on past data, if this government does not increase the household debt ratio, it should be highly praised."

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

- You mentioned that the need for an additional rate hike has decreased compared to before. Is the timing for a 3.75% hike already past? What do the Monetary Policy Committee members think?

▲ Regarding the final interest rate within the next three months, in November, four members said it should be raised to 3.75%, and two said it should be maintained at 3.5%. This time, all five members agreed that (if there is no significant change in outlook) the base rate should be maintained at 3.5% and held for a long period to secure a foundation for price stability. Compared to November, risks related to external economic uncertainties such as the possibility of rising oil prices and the Israel-Hamas conflict have eased. Therefore, realistically, the need for further hikes has significantly decreased. They emphasized that maintaining a tightening stance for a considerable time to stabilize prices is important.

- Regarding the Financial Intermediation Support Loan (FISL), the reserved limit of 9 trillion won was decided to be utilized this time. Does this mean the risk related to Taeyoung Construction has increased? Does it imply that monetary policy will not respond to the real estate PF issue?

▲ Since the Financial Services Commission, Financial Supervisory Service, and government are currently involved, I think it is inappropriate for me to comment on related matters. The Bank of Korea does not respond to crises of specific companies but implements policy responses when shocks hit the market. The Taeyoung Construction incident itself is not severe enough to cause market instability. Therefore, it is not the time for the Bank of Korea to intervene. I hope the Financial Intermediation Support Loan is not directly linked to Taeyoung Construction's real estate PF. Support for FISL requires a time lag and takes about two months to prepare. Considering this period, if done now, it would proceed around February to March. The main reason for this support is that it is still premature to discuss rate cuts, and since high interest rates will be maintained for a considerable period, temporary support for vulnerable companies or small and medium enterprises that may be relatively affected is proposed. There was much discussion in the Monetary Policy Committee. In particular, member Cho Yoon-je expressed a minority opinion that supporting FISL at this time could send a signal contrary to the Bank of Korea's policy emphasizing price stability and monetary tightening. Other members acknowledged such risks but believed that FISL support does not significantly increase overall economic liquidity and that selective, temporary support helps create an environment where the high interest rate stance can be maintained for a long time, thus being more helpful to monetary policy.

- At the end of last year, short-term interest rates surged, and the reverse repurchase agreement (RRP) balance rapidly decreased, leading to talks about adjusting the pace of quantitative tightening (QT). How likely is a sharp liquidity contraction in the US short-term financial market similar to 2019? Will it affect South Korea?

▲ The impact is limited. The US short-term market, which was discussed last October, has now stabilized. In October, concerns about a significant increase in the US fiscal deficit emerged, and with the 10-year Treasury yield exceeding 5%, money moved from short-term surplus funds to the bond market. Now, expectations have eased, and the US 10-year Treasury yield has decreased. Still, if asked whether short-term liquidity problems like those in 2019 could continue, I think the possibility is low. In 2019, the Federal Reserve experienced that QT was not well communicated with the market. After the recent Silicon Valley Bank (SVB) incident, programs such as bank term loan facilities were established to provide liquidity to financial institutions if needed. Also, as I am the chair of the Bank for International Settlements (BIS) Committee on the Global Financial System (CGFS), we have made it a major task to study the pace of QT and bank demand within the BIS. The European Central Bank (ECB) and the US Federal Reserve are researching how the pace of QT affects market stability.

- In your remarks, you said that cutting rates now tends to stimulate expectations of rising real estate prices. Does lowering rates to a neutral level also have this effect?

▲ The range of neutral interest rates is quite broad. Our view remains that the current 3.5% is higher than the neutral rate level. If rates are cut, it is likely to lead to rising real estate prices, not only at the neutral rate but also in the current situation where the economy has various investment options. While rate cuts could have a stimulative effect on the economy, it is important in the current adjustment phase to prevent rate cuts from leading to real estate price increases.

- Since the end of last year, market interest rates have fallen amid expectations of a monetary policy shift. The reversal has not been large. Financial conditions are expected to ease; what level do you consider appropriate?

▲ US Treasury yields rose due to fiscal factors but then fell as the possibility of rate cuts increased. In terms of magnitude, it seems our rates move in line with US rates. Sometimes I wonder whether I decide our rates or the Federal Reserve does. Regarding whether the change in Treasury yields is excessive, it relates to whether the market expects rate cuts in the second or third quarter. The market expects our rates to fall as US Treasury yields decline, which lowers medium- to long-term rates. At the current level, Monetary Policy Committee members think it is premature to cut rates. However, looking at Monetary Stabilization Bonds and Certificates of Deposit (CD) rates, they do not deviate much from 3.5%.

- High interest rates and high inflation continue, and household debt remains high. Consumption capacity, especially among the younger generation, is constrained. Is this a concerning level for economic growth?

▲ A mid-term review shows that consumption has slowed somewhat more than predicted in the November economic forecast, which is concerning because it lowers growth. On the other hand, exports have increased. Despite reduced consumption, growth remains at 2.1%. How much consumption will fall and how much exports will continue are important for growth itself. There is a possibility of polarization between domestic demand and exports this year, so we will examine this further in the February forecast and provide updates.

- Policies that stimulate household debt, such as special loans for newborns, are being implemented. Even if there are negative effects, do you think they are necessary to address low birth rates?

▲ Fundamentally, household debt should be reduced relative to GDP in the medium to long term. The trend toward reduction is visible until the end of the year, and the real estate market is stabilizing and undergoing a soft landing, so I expect household debt will not increase significantly. Real estate prices are important for whether household debt will increase. In this regard, maintaining a high interest rate stance for a long time to reduce expectations of rising real estate prices is appropriate policy. The system itself is good. However, we need to consider whether lending a lot to young people whose income levels are insufficient truly helps them. It is good to help non-homeowners and young people start new married lives, but if they borrow beyond their capacity and rates rise again, it will be difficult. It is important to proceed with debt service ratio (DSR) regulations to some extent.

- You said the Taeyoung incident is not at a stage for central bank intervention. Can it be seen as a problem across the real estate construction industry?

▲ I don't think it is such a situation now. Looking at Taeyoung Construction, its debt ratio and real estate PF relative to equity are significantly higher than other construction companies. It is a case of poor risk management and has attracted attention because it is an important construction company. It is a good example of government restructuring. The possibility of it turning into systemic risk is low. If adjustments are made orderly without systemic risk, there is no need for the Bank of Korea to intervene.

- The government says it has liquidity plans if market instability spreads later. Could this stimulate inflation? Depending on the scale of liquidity support, could monetary policy change?

▲ The liquidity the government talks about and the liquidity the Bank of Korea talks about are different. The government's announcement does not lead to an increase in the money supply. The Bank of Korea has no intention of supplying liquidity through its note-issuing power. The government's support for construction companies or real estate PF is different in meaning from the Bank of Korea's support.

- Recently, the government announced real estate measures such as easing reconstruction regulations. Does this raise expectations of rising house prices?

▲ We need to distinguish between the consumption side and the supply side. Yesterday's announcement is about increasing supply. By informing plans for future supply increases, it has the advantage of stabilizing real estate prices. If prices stabilize, household debt will not increase, so it is a supply-side measure. This measure will help the soft landing of the real estate market.

- In your economic assessment, you said this year's GDP growth rate generally aligns with previous forecasts. The market expects it to fall to the high 1% range. What is the Bank of Korea's view? Many also forecast a slowdown in the Chinese economy; how will that affect the trajectory?

▲ Forecasts are always uncertain. Please look at the assumptions we have rather than the numbers. There is no guarantee that 2.1% is correct. Consumption is sluggish, exports are strong, and investment is volatile. Currently, export growth covers consumption weakness, so it aligns. The Chinese economy is a concern. Especially, the trade structure and supply chain between China and South Korea are rapidly changing. We need to see whether past growth impacts our growth as before. About half of semiconductor exports went to China, but considering tensions between the US and China, it is important whether semiconductor exports will return to China even if China recovers.

- The Monetary Policy Committee's statement still says the monetary tightening stance will be maintained for a "sufficiently long period." Last month, you said it would be at least six months. Is that view unchanged? The government announced plans to reduce the household debt ratio to below 100% of GDP by 2027. Do you agree with that pace?

▲ It is difficult to speak about the Monetary Policy Committee's horizon beyond three months. Within three months, members have no intention of cutting rates. After that, rate decisions will depend on changes in US inflation, whether oil prices remain stable, and consumption trends relative to our inflation path. Personally, I think it will be difficult to predict rate cuts for at least six months. In my opinion, it is hard to predict rate cuts within about six months. I hope household debt falls below 90% in the medium to long term, even after my term ends. House prices should not be significantly higher than incomes. I hope house prices stabilize and regulations work well to gradually decrease. Fixing numbers could cause side effects. I emphasize that it should be lower than the current level. I think this government should be highly praised if it does not increase the household debt ratio. Keeping it lower than the current level until the end of the term is a great achievement.

- Consumer prices have slowed in the second half, but on an annual basis, they rose over 3% for the first time in nearly 20 years, and core inflation has recorded over 4% for two consecutive years. Do you think the Bank of Korea has implemented appropriate price stabilization measures?

▲ Prices were low but rose after the pandemic and the Russia-Ukraine war. Because the baseline was very low, the inflation rate appears high. I think South Korea has performed relatively well. However, the impact of the Bank of Korea's policy on price stabilization should be evaluated after disinflation occurs.

- Different economic agents feel the effects differently.

▲ That is true. There is a difference between the living cost and the CPI inflation we use as a standard, averaging about 0.7% according to data. When prices rise, the difference can widen faster. But this does not mean the perceived inflation statistics are wrong. The items consumers use differ from those used by the entire population. An interesting study we are observing shows that in the US, perceived inflation is lower than CPI. The main difference is energy prices and food items. Energy prices are high here due to high energy dependence, and we hardly import food. Lowering perceived inflation by importing food would cause structural problems. Can food prices be lowered without import liberalization? These are structurally linked issues. The reason we continue to emphasize price stabilization in the short term is that even if inflation falls below 3%, people feel prices about 0.7% higher on average, close to 4%. Therefore, CPI inflation must fall sufficiently to reduce the pain people feel in daily life, so prices need to go down further.