"The Biggest Issue in the Second Half of This Year is the Neutral Interest Rate... Economy in the Second Half Driven by Exports"

KB Securities, Macro Outlook for the Second Half of the Year

The biggest issue in the second half of this year is expected to be the neutral interest rate. The neutral interest rate, which is the long-term appropriate rate reflecting the economic structure, is a theoretical value that cannot be directly observed, so debates surrounding the neutral interest rate are expected to intensify in the second half of the year.

Lee Chang-yong, Governor of the Bank of Korea, is striking the gavel at the Monetary Policy Committee meeting held on the 12th at the Bank of Korea in Jung-gu, Seoul. Photo by Joint Press Corps

On the 29th, Heejin Kwon, a researcher at KB Securities, stated in a report, "KB Securities expects the biggest issue in the second half of this year to be the neutral interest rate," adding, "This will primarily affect long-term interest rates and have an impact on the global financial markets as a whole."

The neutral interest rate refers to the benchmark rate that central banks of each country refer to when setting their policy rates. It is the theoretical interest rate level that neither causes inflation nor deflation and can maintain the potential growth rate level.

Since the beginning of this year, the possibility of an increase in the neutral interest rate has been specifically discussed within the U.S. Federal Reserve (Fed). Researcher Kwon said, "The financial market's attention naturally focuses on how far the Fed will cut rates, and interest in the neutral interest rate, which is the appropriate long-term rate, is growing," adding, "Structural changes have occurred in the U.S. economy after the pandemic, so if the long-term appropriate interest rate has changed, it is necessary to adjust expectations for the final rate level in this rate-cutting cycle."

Kwon analyzed, "Factors raising the neutral interest rate include population growth due to large-scale immigration to the U.S. after the pandemic and improvements in labor productivity, which have actually increased potential GDP, likely causing the neutral interest rate to rise," and "The resulting decrease in savings and expansion of investment changed the supply and demand in the capital market, which is another factor raising the neutral interest rate."

The neutral interest rate in South Korea is estimated to be around 2-3%. The policy rate in South Korea is 3.5%, slightly higher than the neutral interest rate, so the Bank of Korea describes the current level as tight monetary policy.

Researcher Kwon argued that even if the neutral interest rate has risen, its impact on the economy and financial markets should be viewed separately. He said, "If the real neutral interest rate rises in line with the increase in potential growth rate, there is capacity to absorb the higher rates, so the actual negative impact on consumers and corporate economic activities is limited," but explained, "In financial markets, the rise in the neutral interest rate reduces the total number of rate cuts and slows their pace, which is not very welcome."

However, the financial market is already reflecting the possibility of a rise in the neutral interest rate ahead of time. Loretta Mester, President of the Federal Reserve Bank of Cleveland, has mentioned raising the nominal neutral interest rate level to 3.00%.

Regarding the economic outlook for South Korea in the second half of the year, demand from overseas is expected to lead the growth trend of the Korean economy. He said, "Although China's recovery speed is slower than expected, the expansion of demand from the U.S. compensates for this, maintaining a solid export flow," and added, "In the second half, supported by continued export price increases centered on semiconductors, the export growth rate in the third quarter is expected to peak and then slow down in the fourth quarter due to the base effect."