The Bank of Korea raised its benchmark interest rate by a quarter percentage point Thursday in a bid to tame stubbornly high inflation. The central bank’s fourth rate hike in a row, however, did not come as a surprise, as the market had been expecting such a move.
Nonetheless, the problems lurking behind the continued rate hike by the BOK remain as serious as ever. First, it comes in response to almost 24-year-high increases in consumer prices -- 6.3 percent recorded in July compared with a year earlier. This means the government’s hitherto policies to fight inflation were not working as effectively as policymakers had hoped.
Second, the policy rate is now set at 2.5 percent and is expected to reach 3 percent toward the end of the year, a clearly burdensome level for individuals and households who took out loans linked to the changing benchmark rates. Snowballing household debt, if mishandled, could backfire in a vicious way, a worry for economic policymakers.
Third, the outlook going forward is also gloomy. Inflation is forecast to stay in the 5 to 6 percent range until early next year, and the country’s growth was also cut from 2.7 percent to 2.6 percent, reflecting hostile economic conditions both at home and abroad for Asia’s fourth-biggest economy, which is heavily dependent on exports.
One of the most worrying trends outside of Korea is the US Federal Reserve’s unwavering hawkish stance, which will put more pressure on the Bank of Korea in the coming months. On Friday, US Fed Chairman Jerome Powell said they will keep raising interest rates to rein in inflation, despite the short-term pain.
The underlying logic is that if inflation is not brought under control, broader economic conditions will worsen further. Although the need for such rate hikes sounds reasonable, Powell’s firm comment triggered a sharp sell-off in the US stock market.
The US has raised rates by 2.25 percentage points since March after keeping the rate near zero through much of the pandemic, with its rate is now at 2.5 percent. Without the rate hike by the BOK on Thursday, the US rate would have been higher than that of South Korea, a reversal in interest rates that experts repeatedly warn might lead to a flight of foreign capital from the local market.
The possibility of capital going out in search of higher returns may not be high at this point, but warning signs cannot be ignored any longer, as demonstrated by the precipitous fall of the Korean won against the US dollar in recent months.
The Finance Ministry said Friday it would take steps to stabilize the foreign exchange market if market volatility continues as a result of speculative trading in the currency market.
The won weakened past the level of 1,340 won per US dollar for the first time in more than 13 years last week. This year, it has weakened about 11 percent against the greenback, adding to instability for the country’s economy at large.
Local experts have said the government should take more aggressive measures to minimize the negative impact from higher interest rates. This year, the additional interest that households will have to pay due to the rate hikes is estimated to reach 27 trillion won ($20.1 billion). Timely steps to help individuals and small companies hit by the pandemic and struggling to pay back debt are in order.
The Yoon Suk-yeol administration recently unveiled a plan to inject over 125 trillion won of fiscal budget to soften the impact of higher interest rates for vulnerable groups. Given the unfavorable interest rate trends, policymakers should spare no effort to keep inflation under control and help the nation navigate global economic headwinds.
By Korea Herald (email@example.com