Bank of Korea Flags More Rate Hikes to Come Over Inflation Fears
Bank of Korea Governor Lee Ju-yeol signaled the likelihood of more interest rate increases to come following Friday’s hike, as the central bank clearly put inflation concerns ahead of uncertainties over Covid-19.
Even though the key policy rate, now at 1.25%, is back at pre-pandemic levels, Lee said it was at an accommodative level, adding that another hike still wouldn’t amount to a tightening of policy.
The BOK now expects inflation to stay over 3% for “a considerable time” and it was one of the main driving forces behind the need for higher rates, Lee added.
Still, the timing of the next hike is complicated by the ending of Lee’s term as governor and a presidential election in March.
South Korea’s bond futures fell, along with the benchmark Kospi stock index, on the prospect of further rate rises. The won was largely steady.
The rare back-to-back rate hike, even as South Korea faces the threat of an omicron-led infection surge, is the latest indication that accelerating prices have overtaken virus concerns as the key consideration for monetary policy decisions for many global central bankers.
“Inflationary pressures are expected to be much larger than earlier expected,” Lee said at his media briefing after the decision. “There are uncertainties surrounding the pandemic, but they are unlikely to derail the domestic economy’s recovery.”
With the Federal Reserve now poised for an earlier rate liftoff as soon as in March, Lee may also have been keen to stay ahead of U.S. moves and maintain stability in markets that have already priced in more than three Korean rate hikes this year.
Lee’s comments during the briefing “all added justifications for further rate hikes,” said Shin Earl, a fixed-income analyst at SK Securities.
Korea’s three-year government yield jumped 7 basis points to 2.02% on Friday, following the BOK’s inflation forecast and as Finance Minister Hong Nam-Ki said an extra budget will be funded by bond issuance. The Kospi index fell as much as 1.6%, headed for its fourth weekly loss. The won climbed 0.1% against the dollar to 1,187.05 as of 13:59 p.m. in Seoul.
For the BOK board, the government’s extra budget plans likely gave them additional confidence to push ahead with the rate increase and leave it to fiscal policy to tend to any fallout from higher borrowing costs.
Complicating the outlook over when the BOK will move again are uncertainties surrounding who will replace Lee when he finishes his term. The presidential election also makes it unclear who will be naming his successor -- current president Moon Jae-in, whose term officially ends in May, or Korea’s new president.
Lee chairs his final rate decision on Feb. 24.
“It looks like another hike in February or April would’ve been possible if Lee was still the governor, but the election and the new BOK chief will make such a move difficult,” Shin said.
The latest rate move puts the BOK further ahead of global peers in pulling back from pandemic stimulus settings as an increasing number of central bankers consider the timing of their own actions.
Lee said its earlier rate moves give the central bank more room to focus on domestic issues for policy decisions, but added a more aggressive tightening by the Fed would also be an important consideration.
Maintaining a premium over U.S. interest rates can help maintain stability in local markets and prevent a further weakening of the won. Finance Minister Hong ordered officials to closely monitor foreign exchange movements on Monday after the currency reached its weakest level since July 2020 last week.
The Korean central bank had largely justified its initial rate hike in August as a move to avoid financial imbalances building up from prolonged stimulus. While latest data show growth rates in household lending and property prices coming down from their peaks, Lee said the slowdown maybe due to seasonal factors rather than signifying a trend.
The economic backdrop has been supportive of a hike. Despite strict virus curbs in place, the broader economy appears to be holding up better than in previous waves, with export strength continuing and consumption taking less of a hit.
©2022 Bloomberg L.P.