[Q&A] Bank of Korea Governor: "Difficult to Assume Interest Rate Cuts in Second Half... Agricultural Products and Oil Prices Are Variables"

Bank of Korea April Monetary Policy Meeting Press Conference
Difficult to Predict Interest Rate Cuts in Second Half
"Monetary Policy Decoupling in Progress"
"Domestic Factors Like Consumer Prices and Exchange Rates Must Be Considered"

Lee Chang-yong, Governor of the Bank of Korea, said on the 12th that it is difficult to predict an interest rate cut in the second half of the year. Regarding the recent high perceived inflation, he pointed out that it is time to consider structural issues such as climate change.

At a press conference held immediately after the Bank of Korea's Monetary Policy Committee's 10th consecutive decision to keep the base rate unchanged (3.5% per annum), Governor Lee explained, "There is talk that the Bank of Korea has turned on the interest rate cut indicator," adding, "Currently, it is not a situation where the indicator is turned on, but rather a situation where we are considering whether to turn it on or not."

Regarding the possibility of Korea cutting interest rates before the United States, he said, "Globally, interest rate policy decoupling is progressing," and "We now have greater capacity to operate monetary policy by considering domestic factors such as consumer price inflation and exchange rates."

On the recent high perceived prices of agricultural products and apples, he pointed out, "Prices of agricultural products and apples are affected by climate change," and that government subsidies through fiscal measures cannot be a fundamental solution. He added, "High inflation levels are not something to be solved by monetary or fiscal policy," and said, "When climate change issues worsen, it is time to consider whether to continue fiscal policies like now to protect producers or to resolve the issue through imports, reflecting on structural problems such as climate change."

Below is a Q&A with Governor Lee.

- What are the Monetary Policy Committee members' interest rate forecasts for three months later?

▲ In the February Monetary Policy Committee meeting, 5 out of 6 members agreed that maintaining the 3.5% rate three months later is appropriate, while one member kept open the possibility of lowering it below 3.5%. The five members mentioned the need to continue a tightening stance until there is confidence that core inflation and consumer price inflation converge to the target. The remaining member expected a continued underlying inflation slowdown despite supply-side uncertainties and left open the possibility of a cut if domestic demand remains sluggish. There is little difference from the February decision statement.

- The slowdown in core inflation was emphasized more than in June. Between headline inflation and core inflation, which is given more weight?

▲ The two inflation measures have moved almost together until now, but inflation trends are now clearly diverging. Inflation expectations are heavily influenced by consumer price levels, which cannot be ignored. In advanced financial countries, core inflation is actually higher while headline inflation is lower. Our concern is that while core inflation is slowing as predicted, the rise in agricultural product prices over the past two months has caused headline inflation to behave differently. Given the increased uncertainty in inflation forecasts, we need to observe whether headline inflation moves as expected.

- Inflation worldwide is showing a bumpy pattern. The possibility of delayed interest rate cuts is increasing. How do you see the next six months?

▲ In January, I personally said that interest rate cuts would be difficult in the first half of the year. All Monetary Policy Committee members think it is difficult to predict interest rate cuts in the second half. Core inflation is as expected, but consumer price inflation, including agricultural products and oil prices, is uncertain. We need to watch whether consumer price inflation aligns with the forecast of 2.3% by year-end before entering the second half. Some members do not exclude the possibility of rate cuts in the second half. If consumer price inflation exceeds 2.3%, rate cuts in the second half may be difficult.

- The phrase "for a sufficiently long period" in the monetary policy statement was changed to just "sufficiently." What does this mean?

▲ If we wrote "for a sufficiently long period," it might send a message that rate cuts are impossible in the second half. Removing the phrase entirely might imply that rate cuts are possible in the second half. There is talk that the Bank of Korea has turned on the interest rate cut indicator. Currently, it is not turned on; we are considering whether to turn it on or not.

- Predictions suggest fewer and later rate cuts in the U.S. Is there a possibility that Korea will cut rates before the U.S.?

▲ It is true that the timing of U.S. rate cuts is being delayed. The U.S. rate hike stance has made monetary policy adjustments difficult due to strong U.S. influence. The U.S. will pivot eventually, but the timing is the issue, so the impact on monetary policy is different from before. Globally, interest rate policy decoupling is progressing. We now have much greater capacity than last year to operate monetary policy by considering domestic factors such as consumer price inflation and exchange rate impacts.

- Between core inflation and consumer price inflation, which is weighted more?

▲ Both must be considered. We cannot mechanically assign weights. The important point is that people's expectations are more influenced by consumer price inflation (headline). We need to observe how both affect expectations. Headline inflation relates to expected inflation, while core inflation is related to domestic demand weakness.

- Last year, you mentioned that if oil prices rise above $90 per barrel, inflation forecasts would change. Is there a possibility of upward revision in inflation forecasts?

▲ The February forecast assumed oil prices in the high $80s. The Bank of Korea's forecast is an average, so a temporary rise and fall does not significantly deviate from the forecast. However, if oil prices remain high for a long time, the inflation forecast must be revised. Agricultural product prices are expected to fall over time, but oil prices are difficult to predict due to conflicts like Iran-Israel.

- In February, you answered that inflation uncertainty had decreased. Do you still see uncertainty as low?

▲ Over the past two years since the pandemic, forecast errors were quite large, similar in the U.S. and Europe. Currently, inflation has dropped significantly, and forecast errors have decreased from 6.3% to around 3%. Inflation forecast uncertainty has decreased compared to before. However, short-term inflation uncertainty has increased due to oil price fluctuations.

- Earlier, you mentioned the possibility of Korea cutting rates before the U.S. In February, you said that a U.S. pivot was necessary for monetary policy differentiation. Has your outlook become more optimistic?

▲ When the U.S. signals a pivot, conditions for decoupling are created. Since the U.S. has already signaled a cut, decoupling has begun. Previously, we had to consider both domestic and international factors due to U.S. monetary policy. Now, with the U.S. pivot signal, we have greater capacity to consider domestic factors. This means Korea could cut rates before or after the U.S. Please interpret the U.S. pivot signal as creating conditions for decoupling.

- The exchange rate has reached around 1,360 won.

▲ The exchange rate is influenced by the strong dollar, so this rise is not unique to Korea. Unlike before, there are many Korean investors investing abroad, and overseas net assets have increased significantly. Previously, when the exchange rate rose, government bond issuance was used, but not now. Korea has established an advanced foreign exchange market structure with entities like the National Pension Service, pension funds, Korean investors abroad, and overseas assets. However, the exchange rate exceeding 1,350 won reflects delayed expectations for the U.S. rate cut pivot. China and Japan are also under pressure to depreciate the yuan and yen. We are closely monitoring whether Korea's exchange rate is excessively depreciated relative to fundamentals. If excessive volatility occurs due to the strong dollar and regional influences, we have various measures to stabilize the market and exchange rate.

- Global investment banks predict U.S. rate cuts after September. There are criticisms that the Bank of Korea's political independence has weakened. What is your view? Does it affect monetary policy decisions?

▲ It is true that the timing of U.S. rate cuts has been pushed back. We need to watch variables like exchange rates and inflation to see how it affects our monetary policy. At central bank governors' meetings, we may learn about U.S. views. Unlike the ongoing U.S. rate hike stance, when watching the pivot timing, we can independently consider internal factors to decide monetary policy.

- Domestic inflation and Federal Reserve policy uncertainties make it difficult to gauge monetary policy direction. Will the May forecast be clearer?

▲ The May forecast will be more important than usual. We need to consider various unforeseen variables in the first half (exports, oil prices, etc.). Whether we can clearly forecast second-half monetary policy in May requires about a month of observation. We also need to see how exchange rate changes due to monetary policy decoupling affect inflation. Personally, I think it is better to review data twice to gain confidence. Premature rate moves could cause inflation to fluctuate again. We will watch global central bank decisions.

- Two Monetary Policy Committee members retire this month. Is a significant change in forward guidance expected at the next meeting?

▲ We are discussing internally. How to improve it will reflect the opinions of new members. Even if changed, it will be next year. Research is ongoing internally this year.

- The monetary policy statement said this year's growth rate could be similar or revised upward from the February forecast. Why?

▲ First-quarter GDP data will be released at the end of April. We won't know until official data is out. However, exports are increasing faster than expected. To clearly see if domestic demand is also affected, we need to see the provisional first-quarter data at the end of April. The certain point is that exports have risen. More data is needed on domestic demand.

- You said monetary policy changes require confidence that consumer price inflation converges to the target. If core inflation follows the path but consumer price inflation does not fall, continuing tightening could excessively suppress domestic demand and the economy. What is your view?

▲ We are watching whether supply shocks overly affect expectations. If monetary policy is based solely on the CPI index, domestic demand could worsen and recession deepen. We are considering core inflation together to avoid such mistakes.

- Inflation is high, causing public hardship. Are you considering monetary policy that tolerates some inflation?

▲ You may be referring to average inflation targeting. The consensus among central banks is that average targeting can increase volatility. It may lag economic changes and increase instability.

▲ This is a very important question. Inflation levels are currently high. Globally, high inflation is driven by agricultural products and housing, while utilities, electricity, and transportation costs are low. The central bank's dilemma is that high agricultural product and apple prices are affected by climate change. Rising prices of agricultural products and apples affect living costs. The government can stabilize prices through subsidies.

▲ However, fundamentally, increasing cultivation areas or fiscal spending may not solve the problem. Suppose cultivation areas are increased for next year, but weather improves due to climate change, causing prices to collapse. Then producers suffer, and the government must increase subsidies again. The uncomfortable truth is that high inflation levels cannot be solved by monetary or fiscal policy. Whether to continue current policies to protect producers amid severe climate change or resolve through imports is a choice for the public. Many think improving distribution is enough, but now is the time to consider structural problems caused by climate change.

- Household debt is managed at a stable level, but corporate debt has risen significantly. Non-bank financial institutions face overlapping risks such as real estate project financing (PF). Is this manageable?

▲ Two reasons for increased corporate debt are that real estate-related companies' debt has risen significantly over recent years, and investments in new industries like AI and semiconductors have increased. Investment in new industries is positive even if debt rises. Although debt ratios have increased, invested companies' capital has also grown. If companies manage by increasing capital alongside debt, this is a positive trend.

- You mentioned that core inflation will fall to around 2% by the end of this year. You did not specify a timing for consumer price inflation. When do you expect it to reach around 2%?

▲ The February announcement forecast consumer price inflation at 2.3% in the second half and core inflation around 2.0%. The downward trend in core inflation is proceeding as expected. However, consumer price inflation depends heavily on current oil prices, so it is difficult to predict. We will decide monetary policy direction based on the situation.

- Authorities consider real estate PF risks manageable. However, rapid resolution could increase risks centered on vulnerable financial institutions. How do you view these risks?

▲ I understand that improvement plans regarding Taeyoung Construction will be announced soon. The Financial Services Commission and Financial Supervisory Service are cooperating well in the process, which I view positively. It is difficult to say that no financial institutions or real estate will fail. However, if real estate prices related to PF fall, many investors are willing to invest. Thus, financial conditions for restructuring are being created. I think the Financial Supervisory Service and Financial Services Commission have set a good example with the Taeyoung Construction restructuring.