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| Bank of Korea (BOK) Governor Rhee Chang-yong bangs a gavel during a rate-setting meeting at the BOK headquarters in central Seoul, Wednesday. Yonhap |
Base rate expected to climb to 3% by year-end
By Yi Whan-woo
The Bank of Korea (BOK) took an unprecedented "big step," Wednesday, lifting its key interest rate by half a percentage point in a preemptive move to fight runaway inflation and curb a possible capital outflow amid the U.S. Federal Reserve's faster-than-expected monetary tightening.
The central bank said its monetary policy board decided during a rate-setting meeting earlier in the day to increase the policy rate to 2.25 percent from 1.75 percent, marking the third consecutive increase of the benchmark rate.
The unprecedented move comes as the nation's consumer prices rose 6 percent in June from a year ago, growing at the fastest clip in 24 years. The previous record increase in consumer prices was in November 1998, in the wake of the Asian financial crisis, when the prices jumped 6.8 percent.
The rate hike also comes as the U.S. dollar is getting stronger and the market expects a more hawkish monetary policy to grapple with the plunging Korean won, widening trade deficit and accelerated outflow of foreign capital.
More foreign investors may pull out of Korea in search of safe-haven assets if the interest gap between Korea and the U.S. is reversed depending on the outcome of the U.S. Fed's rate-setting meeting from July 26 to 27. The U.S. base rate currently ranges between 1.5 percent and 1.75 percent.
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Under the circumstance, BOK Governor Rhee Chang-yong hinted at additional rate hikes in this year's remaining rate-setting meetings in September, November and December.
"It would be rational to forecast the key interest rate to reach between 2.75 percent and 3 percent by the end of this year," he said during a press conference at the BOK's headquarters in central Seoul.
He noted that the pace of inflation has been accelerating and that such a forecast should "be taken for granted."
According to the BOK, it took seven months for inflation to climb from 3 percent to 5 percent, and then just a month to rise from 5 percent to 6 percent.
The BOK projects inflation to peak at the end of the third quarter or early fourth quarter, although global economic uncertainties are "too huge to predict when such a peak will happen."
Correspondingly, Rhee explained the year-end rate will depend on the rate policies of the advanced economies, global oil prices and other external factors.
Meanwhile, this is the first time that the BOK increased the benchmark interest rate three times in a row, including quarter-percentage-point rises in April and May.
Asked whether Wednesday's hike suggests a shift towards a more tightened monetary policy, the BOK chief said, "Not necessarily."
Concerning the possibility of another "big step," he said adjusting the base rate by 25 basis points as usual is appropriate, but it can change depending on the pace of inflation.
But analysts forecast the policy rate to stay at 2.75 percent at the highest, arguing that the risk of recession is weighing on the global economy and that moving too fast on the rate is not recommended.
"I don't think even the Fed can keep raising the interest rate considering the recession fear," said Cho Young-moo, a researcher at LG Economic Research Institute. "Similarly, chances will be slim for the BOK to take another 'big step' this year, especially as the government is tightening its belt to reduce the fiscal deficit."
Park Jeong-woo, chief economist at Nomura Securities' Seoul office, voiced a similar view, saying, "A steeper rate hike is adding to worsening household debt-related issues."
The key rate jumped by 1.75 percent for the past 10 months, and the interest burden on those who took out loans is estimated to increase by 24 trillion won ($18.4 billion). The country's household debt as of March stands at 1,752 trillion won.
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