The Korea Herald


[Editorial] A tricky decision

Bank of Korea should refrain from hasty reversal of course given growing risk factors

By Korea Herald

Published : Feb. 21, 2023 - 05:31

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The Bank of Korea is scheduled to announce its benchmark interest rate on Thursday, following heightened attention on the market and growing concerns over their tightening monetary policy.

Last month the central bank raised its interest rate by 25 basis points to 3.5 percent, a seventh straight rate increase since April last year. It also marked the 10th rate hike, totaling a combined 3 percentage points, since August 2021, when the BOK started “normalizing” the low rate.

Opinions are divided as to whether the BOK should halt the rate raise and consider reversing course in the near future. Some economists hold the view that the Korean economy is in poor shape on many fronts, including exports, so it should keep the rate steady and watch how its previous rate increases play out.

Other experts predict the central bank will increase the rate by a quarter of a percentage point to 3.75 percent this week in reaction to high inflation and a wide gap in interest rates between South Korea and the United States.

The US Federal Reserve Board opted to lift its benchmark rate by 25 basis points to a range between 4.5 percent and 4.75 percent at its Jan. 31-Feb. 1 policy meeting. The gap of 1.25 percentage points between the two countries will widen further if the BOK freezes its rate and the Fed goes for more rate hikes in the coming months.

The Fed has already signaled more hikes in borrowing costs to lower inflation back to a desirable level. It is expected to keep the benchmark rate above 5 percent and hold it there for some time to bring inflation down to the 2 percent target, Fed officials were quoted as saying last week. This suggests the inflation problem in the US has not been fixed.

The same inflation problem still haunts the Korean economy. The country’s consumer prices, a key gauge of inflation, rose 5.2 percent last month from a year earlier, continuing a nine-month upward trend, according to Statistics Korea.

The inflation figure has remained above 2 percent -- the BOK’s midterm inflation target -- for 22 months. And it seems unlikely that consumer prices will fall at a fast pace going forward.

Even though President Yoon Suk Yeol last week asked the central government to freeze public utility rates and for provincial governments to cooperate in stabilizing utility fees at least for the first half of this year, the prices of energy, food and other daily necessities remain volatile.

After peaking at 6.3 percent in July last year, inflation is slowing down, but the pace of that downward trend is not fast enough, which in turn supports the voices of experts forecasting another rate hike of 25 basis points Thursday.

Volatility on the foreign exchange market is also a factor to consider. In recent weeks, the Korean won has weakened against the US dollar. A continued depreciation of the Korean currency could translate into higher prices of imported goods and energy -- an important development that will keep inflation at a high level.

The dilemma for the BOK is that it cannot ignore deepening troubles for the Korean economy as a whole. On Feb. 16, the Finance Ministry officially admitted that the Korean economy has entered a slowdown phase. Domestic spending is weakening amid high inflation, while exports are rapidly dropping, increasing the trade deficit.

At this point, persistently higher interest rates would certainly hurt the economy, dimming the prospect of what is called a “soft landing,” in which the central bank completes a cycle of interest-rate rises without sparking a recession.

For all the difficulties, however, the economic slowdown is a problem that policymakers should tackle, and what the BOK should focus on right now is whether it can bring inflation under control with a proactive monetary decision.