[Q&A] Lee Chang-yong: "We Must Keep Both Rate Cut and Hold Options Open... No Consideration of a Hike"

November Monetary Policy Board Press Conference
Lee Chang-yong: "Base Rate Held Steady, Only Shin Sung-hwan Supported a Cut"
Three Members Favor Additional Cut Within Three Months, Three Support a Hold
"Interpreting This as the End of the Easi

Lee Changyong, Governor of the Bank of Korea, stated on the 27th, "For the time being, we need to keep open the possibility of both an additional base rate cut and maintaining the current rate." He drew a clear line, saying that it is not the stage to discuss a rate hike at this point.

Lee Changyong, Governor of the Bank of Korea, is speaking at a press conference held at the Bank of Korea in Jung-gu, Seoul on the 27th. Photo by Yonhap News

At the monetary policy direction press conference held that day, Governor Lee explained, "Although the growth outlook has been revised upward, there are both upside and downside risks potentially affecting the future path. Financial stability risks persist, such as heightened expectations for rising real estate prices and increased exchange rate volatility, and inflation has also risen somewhat. We have taken these factors into consideration."

The Monetary Policy Board of the Bank of Korea decided to keep the base rate unchanged at 2.5% per annum. This year's economic growth rate is forecast at 1.0%, up 0.1 percentage point from the August projection of 0.9%, and next year's growth rate is expected to be 1.8%, an increase of 0.2 percentage point.

Regarding the background of the outlook, Governor Lee explained, "We believe that exports and facility investment will grow faster than initially expected due to the conclusion of the Korea-US trade negotiations and the global semiconductor market boom. On the consumption side, the recovery is expected to accelerate further as the effects of expansionary fiscal policy and improved economic sentiment grow." However, he added, "Looking at recent growth trends, the IT sector, including semiconductors, remains robust, while sectors heavily affected by tariffs and local small and medium-sized enterprises continue to underperform. It is necessary to closely monitor the developments of various risk factors."

The following is a Q&A with Governor Lee.

-Was there a dissenting opinion in this Monetary Policy Board decision?

▲Monetary Policy Board member Shin Sungwhan expressed the view that it would be desirable to cut the base rate. The five board members who supported maintaining the rate argued that, compared to the previous meeting, growth is recovering and concerns over exchange rates and financial stability in the real estate sector have not been resolved, so it is appropriate to keep the rate unchanged. In contrast, member Shin Sungwhan, despite the upward revision of the future growth and inflation path, argued that, excluding the base effect, the recovery pace in the real private sector remains slow, so it would be better to cut the rate quickly and observe the effects for a while before making further decisions.

-What are the Monetary Policy Board members' outlooks for the base rate over the next three months?

▲Among the six board members excluding myself, three believe it is highly likely the rate will be maintained at the 2.5% level after three months, while the other three think the possibility of a rate cut below the current 2.5% should remain open. The three who support maintaining the rate cited the significant increase in exchange rate volatility and growing inflation concerns as reasons to keep the rate unchanged for the time being and monitor changes. The three who see a possibility for a cut believe that, given the upside and downside risks to the growth path and uncertainties regarding the US Federal Reserve's future monetary policy, it is still necessary to keep the option of a rate cut open.

-Does the 3-3 split between maintaining and cutting the rate suggest a policy shift?

▲Please understand that both a rate cut and maintaining the rate are open options. Interpreting this as the end of the rate-cutting cycle is a personal judgment. However, none of the board members proposed discussing the possibility of a rate hike. I do not think it is the stage to discuss a rate hike at this point. On average, it takes about 12 months to move from a rate hold to a rate hike, so it is rare to shift directly from a cut to a hike. Therefore, do not interpret this policy transition as a move toward a rate hike.

-According to the Bank of Korea's outlook, the growth rate remains at the potential growth rate level and seems heavily reliant on the semiconductor market.

▲The 1.8% growth forecast for next year is indeed led by the IT and semiconductor cycles. Internally, we expect the non-IT sector's growth rate next year to be around 1.4%. Since it is still below the potential growth rate, the output gap between the two is likely to narrow slowly. Board members who think it is difficult to declare the end of the rate-cutting cycle seem to view the semiconductor sector's performance as somewhat of an illusion.

-When do you expect the gap between real GDP growth and potential growth (the output gap) to close?

▲The output gap is negative, so why isn't inflation falling, and why is it rising? There was also discussion today about whether the potential growth rate is falling even faster than previously thought. The potential growth rate varies significantly depending on the model, but in any case, it is negative compared to the present. Even at the earliest, the output gap is expected to close by late 2026 or early 2027, and at the latest, by the end of 2027. However, this does not mean that monetary policy will not change until the output gap is fully closed.

-Do you see the current high exchange rate, in the mid to high 1,400 won range, as a burden on the Korean economy?

▲There are concerns about the exchange rate level, but over the past few weeks, I have been more worried about two aspects. First, rather than volatility, there is an excessive bias in one direction. Second, the recent rise in the exchange rate appears to be driven by domestic investors' overseas stock investments, which is concerning. In the past, when the US dollar was strong, the won moved in line with other currencies, but in recent weeks, the won has depreciated more than others. I believe this is related to the concentration phenomenon.

▲However, even if the exchange rate exceeds 1,400 won, there is no instability in the foreign exchange market, as the banks' foreign currency liquidity coverage ratio (LCR) and external debt burdens are not causing financial stability risks or a financial crisis. Therefore, while it is not a financial stability issue, the monetary authorities are very concerned that the high exchange rate could push inflation higher.

▲Additionally, while those investing overseas may see significant book profits in the short term, it is questionable whether they will realize returns when repatriating funds, especially if leverage is involved. There is much talk about an AI bubble in overseas stocks, and with so much capital flowing out, I am concerned about whether risk management is being properly conducted. Exporters benefit from the high exchange rate, but domestic-oriented companies lose out, which also impacts the domestic economy. The current situation differs from the past when there was a high level of national external debt or when the US rapidly raised interest rates, causing global currency and dollar strength. Recently, the concentration phenomenon resulting from Korean investors' overseas stock investments has become a major concern.

-Do you believe that the end of the rate-cutting cycle would ease upward pressure on the exchange rate and real estate?

▲If the rate-cutting stance disappears, it would signal that liquidity will not be excessively supplied, which could have a positive effect on the exchange rate and real estate. However, as I always emphasize, exchange rates and real estate cannot be viewed solely through the lens of monetary policy. For example, the current phenomena are occurring despite the Korea-US interest rate gap narrowing compared to before. Foreign investors are buying a lot of bonds now, although they are selling futures, but since futures only affect the difference in settlement prices, their immediate impact is minimal. Therefore, the current exchange rate issue is not about interest rates but about capital outflows to overseas stock markets, so I do not believe a reduction in the rate-cutting stance will have a significant impact on the exchange rate. As for real estate, it is difficult to curb price increases with demand suppression measures alone, so a comprehensive approach, including supply, is necessary.

-Are you concerned about the exchange rate surpassing 1,500 won?

▲I am not worried about the exchange rate level itself. However, my concern is that the current move toward 1,500 won is not due to the Korea-US interest rate gap or external factors, but rather the trend of overseas stock investments becoming a craze. I am concerned about whether risk management is being conducted for overseas stock investments and how exchange rate risk is being managed.

-Recently, a four-party consultative body involving the government and the National Pension Service was activated to stabilize the exchange rate. However, there are concerns about involving the National Pension Service in defending the exchange rate. Do you believe it is necessary to mobilize the National Pension Service at the risk of endangering retirement assets?

▲The National Pension Service involves many issues that are difficult for non-experts to understand. Deputy Prime Minister for Economic Affairs Koo Yooncheol also held a press conference yesterday, and there were many negative articles in the media such as 'mobilizing the National Pension Service' and 'holding retirement assets hostage,' which is unfortunate. To clarify from the foreign exchange authorities' perspective, we are not asking the National Pension Service to do everything, but there are quite a few things that can be done within the current system. Rather than sacrificing retirement assets, a new framework is actually needed to protect them.

▲Our pension insurance premiums are increasing, and especially with parametric reforms, the assets managed by the National Pension Service are growing rapidly. In about ten years, as the population ages, there will come a time when the assets invested must be quickly brought back for payments. Unlike global investment institutions that maintain stable asset sizes, our structure is unique. Therefore, when a lot of money is sent overseas, it inevitably causes depreciation pressure on the won, and when assets are repatriated, it creates appreciation pressure. During depreciation phases, returns look high in won terms, but when assets are brought back, the appreciation pressure can lower returns. To protect retirement assets, it is necessary not only to look at book returns but also to consider the exchange rate when repatriating funds, so some degree of exchange rate hedging and various methods to secure profitability are needed. I believe it is time to consider performance from this medium- to long-term perspective.

▲Currently, the National Pension Service determines how much to allocate overseas, when to hedge foreign assets, and when to unwind hedges according to rules set by the National Pension Fund Management Headquarters. Although this is confidential, in reality, everyone knows the cards. Roughly, when the exchange rate reaches a certain level, hedging begins, so we need to be cautious. Conversely, when it falls below a certain level, hedges are unwound, so it's fine. Overseas investors are well aware of these boundaries, so all the cards are on the table. As someone responsible for exchange rate management, this makes things very difficult.

▲Basically, the National Pension Service has room for flexibility, but not only the National Pension Service but also domestic asset managers are reluctant to use this flexibility because they are held accountable for losses from hedge plan changes but are not rewarded for gains. As a result, there is a tendency for the exchange rate to move in one direction. The new framework aims to increase strategic ambiguity and provide flexibility to respond according to the exchange rate level, but since no one wants to take responsibility, the exchange rate becomes biased. The purpose of the new framework is to foster strategic ambiguity and enable flexible responses based on the exchange rate level.

▲When the National Pension Service first started investing overseas, individuals did not take assets abroad, but now, with legal changes and domestic conditions, much more money is going overseas. In terms of the National Pension Service's role in the country's overall portfolio, if individuals are sending out large amounts, there should be some coordination to optimize the national portfolio. If the private sector is investing abroad and the National Pension Service also mechanically follows, the exchange rate will become more biased. Considering these macroeconomic effects is necessary. I understand that those managing the fund may question how they can consider all these macro effects when they are not the government. However, given the size of the National Pension Service and the significant side effects through the foreign exchange market, it is no longer feasible to ignore macroeconomic impacts. If it is difficult to handle this independently, I believe it would benefit the entire nation to improve the system through four-party consultations with the Bank of Korea and the Ministry of Economy and Finance, who do take macroeconomic considerations into account.

-Are there any other measures, besides the National Pension Service, that can be considered to stabilize the exchange rate?

▲There are other measures. However, the ambiguity lies in how to prevent individuals from sending money abroad and whether intervention is necessary. The Ministry of Economy and Finance is currently discussing whether other methods should be considered. If the concentration phenomenon subsides, individual investors may return as they will need to manage risks.

-The currency swap between the Bank of Korea and the National Pension Service will expire next month. Do you think it should be extended or the scale increased?

▲The issue is how much to use, not whether to extend it. Discussions are ongoing at the working level. I believe that strategic currency hedging is something the National Pension Fund Management Headquarters should do for their own benefit. It would be better to allow flexibility and set parameters within that. As I mentioned earlier, the current system does not reward performance but holds people accountable for losses, so even available options are not being used and all the cards are revealed. Adjusting to the appropriate level would help protect retirement assets. However, it is not a situation where the government should dictate the amount.

-The inflation outlook is somewhat higher than expected. Are there any additional upside risks? What is the impact of the government's expansionary fiscal policy on inflation?

▲The main upside risk to inflation is the persistently high exchange rate, which is higher than we expected. If inflation rises due to the high exchange rate, there could be adverse effects on low-income groups. Previously, we said the impact of expansionary fiscal policy on inflation was limited, but since government spending has increased significantly this year and will rise further next year, we need to reassess the potential impact if fiscal expansion continues to accumulate.

-Bond yields have risen significantly. Is there a possibility they could rise further?

=We have been in a rate-cutting cycle, and the expectation of further cuts led three board members to predict a hold rather than a hike, which places a burden on securities firms with large bond positions and their dealers. Bond yields are bound to fluctuate during such transition periods. However, if yields rise much more than we anticipate, we would consider various options such as open market operations (a type of direct government bond purchase or open market manipulation). For now, the rise in bond yields, investment returns, and lending-deposit spreads is a natural part of the policy transition process.

-Some argue that the recent rapid increase in real estate asset prices is due to abundant liquidity. How do you assess the speed and scale of liquidity growth at the current base rate?

▲It is true that liquidity has been abundant, but I do not believe a significant amount of new liquidity has been injected. I believe that liquidity released in the past has shifted to long-term investments and has changed the composition of broad money (M2). Technically, M2 includes asset management firm beneficiary certificates such as ETFs. In September, M2 increased by 8.5%, but excluding the inflow into stock market ETFs, the increase is about 5.5%. Liquidity released in the past has moved from other areas into housing purchases or stock investments. Overall, including the past, liquidity remains abundant. The movement of this liquidity affects fluctuations in real estate and stock asset prices. Some may ask why we are excluding certain components now, but the International Monetary Fund (IMF) has recommended excluding asset management firm beneficiary certificates from M2, and we plan to announce both the existing and new versions by the end of this year.