[The Editors' Verdict] Let's Accept a Base Interest Rate Around 3% as the New Normal

Looking at our economic situation, the first-quarter growth rate (compared to the previous quarter) recorded 1.3%, significantly surpassing the existing market forecast of 0.6~0.7%. Accordingly, the Bank of Korea raised its annual growth rate forecast from 2.1% to 2.5%. The Korea Development Institute (KDI) also recently increased its forecast from 2.2% to 2.6%.

Although there are many expectations that the economy will improve, the general public still feels a heavy burden from high inflation and high interest rates. The Bank of Korea expects the consumer price inflation rate to decrease from 2.9% in the first half of this year to 2.4% in the second half. It is forecasted to fall further to 2.1% next year.

So, what will happen to the Bank of Korea's base interest rate? On the 23rd, at a press conference following the Monetary Policy Committee meeting, Lee Chang-yong, Governor of the Bank of Korea, said, "If we confirm that the inflation rate is trending down to 2.3~2.4% (monthly average in the second half), we may consider lowering the interest rate."

Currently, the Bank of Korea's base interest rate is 3.5%, and the U.S. base interest rate is 5.25~5.50%, but the market's expected timing for interest rate cuts is gradually being pushed back. According to a survey conducted by Asia Economy from the 13th to the 17th among 20 economic experts, including domestic and international bank and economic research institute economists and securities firm researchers, 65% (13 out of 20) of the experts expected Korea to cut the base interest rate in the fourth quarter. This is a significant difference compared to last month's survey, where only one person expected a rate cut in the fourth quarter. Last month, 18 experts anticipated a cut in the third quarter, but the outlook has been delayed. Regarding the U.S., the number of people expecting a rate cut in the third quarter increased from 8 in last month's survey to 16 this month.

Whether in Korea or the U.S., the market had optimistically expected interest rate cuts, but inflation is still far from converging to the central bank's target of 2%. It seems the market's expectations might be a form of 'hope torture.' Some even hold a pessimistic view that a U.S. interest rate cut within this year is unlikely.

In any case, the base interest rate will continue to trend downward until the end of next year. However, the magnitude of the cuts is likely to be smaller than expected. In the U.S., the market expects two cuts this year (0.5 percentage points) and four cuts next year (1 percentage point). In Korea, the market forecasts two cuts this year (0.5 percentage points) and one to two cuts (0.25~0.5 percentage points) in 2025~2026.

This perspective does not seem to be well known among the general public. Many people suffer from high interest rates and most want the base interest rate to be lowered quickly and significantly, but the likelihood of that happening is small. Even if the base interest rate falls by the end of this year, it will remain at 3.00%, and if the timing of the cut is delayed further, it will stay at 3.25%. By next year or the year after, the base interest rate will at best be around 2.50~2.75%, not going any lower.

Even this reflects the current market expectations for interest rate cuts, and the actual cut could be smaller. The timing of the cut could also be pushed back further, as has happened before. If a recession occurs next year, the base interest rate could be cut more significantly and earlier, but currently, that possibility seems low. Rather, depending on the U.S. presidential election results in the second half of this year or geopolitical factors such as the Russia-Ukraine war and Middle East conflicts, there is a greater chance that oil prices will rise and globalization will retreat, leading to higher inflation.

In conclusion, it seems necessary to abandon expectations of a significant interest rate cut and accept a base interest rate around 3% as a constant. Thinking back, before the 2008 global financial crisis, Korea's base interest rate never fell below the 3% level. This only happened due to unconventional monetary policies like quantitative easing in the U.S. and Europe, and the unusually low inflation environment of the 2010s when China firmly established itself as the 'world's factory.' A base interest rate around 3% might actually be normal.

Trends in the Bank of Korea Base Interest Rate