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[Editorial] Rate hike conundrum

Authorities have to minimize adverse effect of higher rate on the market amid gloomy outlook

Jan. 16, 2023 - 05:30 By Korea Herald

The Bank of Korea raised the benchmark rate by 25 basis points to 3.5 percent Friday, extending its tightening mode with a seventh straight rate increase dating to April last year, amid expectations the central bank might soften its hawkish stance sooner rather than later.

The rate hike seems inevitable in consideration of stubbornly high inflation and other related market conditions. Since August 2021, the BOK has raised the benchmark rate by a combined 3 percentage points through 10 hikes to bring inflation under control, even at the risk of slowing down the Korean economy, already beset by the pandemic and surging prices of imported materials.

Overall economic conditions show no sign of a quick recovery. Consumer prices rose 5 percent on-year in December, which is still uncomfortably high, given the BOK’s target range of 2 percent. Inflation pressure, though moderating, is likely to stay at around 5 percent for the time being, according to the central bank.

Three key indicators -- exports, domestic consumption and corporate investment -- all remain languid amid concerns that higher interest rates put greater burden on both individual and corporate borrowers, making it difficult for those who struggle under heavy debt to stay afloat.

The negative factors combine to raise expectations that the central bank might stop raising the rate further and start cutting the rate within this year to help bolster the beleaguered economy.

This is why some experts float the possibility that the central bank might slow the pace of rate increases or keep the rate at 3.5 percent for a while, despite that BOK Gov. Rhee Chang-yong told reporters Friday it is “premature” to discuss a rate cut before the end of this year.

In general, the central banks needs a clear sign of inflation ebbing before switching to a dovish mode. A hasty move could complicate not only the country’s strategy to fight inflation, but also reduce key tools to shore up the economy if it is hit by a recession with market conditions suddenly turning volatile on multiple fronts.

Korean financial authorities and policymakers may prefer a freeze of the benchmark rate in the coming months, but the BOK faces a host of unpredictable factors that could require additional rate increases. Steep increases in consumer prices, raw material prices and the US Federal Reserve’s continued rate hikes could put extra pressure on the central bank to raise the rate.

The Fed raised its benchmark interest rate by half a percentage point to a target range between 4.25 percent and 4.5 percent in mid-December, the highest level in 15 years. In the upcoming rate-setting meeting, the Fed is expected to raise the rate by 50 basis points again to a range between 4.75 percent to 5 percent. This will widen the gap between the US and Korea’s benchmark rates to as high as 1.5 percentage points, which in turn poses higher risks involving the weakening of the Korean currency and the outflow of foreign funds seeking higher interest income.

The latest rate hike of 50 basis points would translate to additional interest payments of 6 trillion won ($4.85 billion) for households and companies, local media outlets projected. As financial authorities push commercial banks here to refrain from raising interest rates for savings and loan products, the actual market rates may not rise in step with the BOK’s rate hikes. But this means that banks are given a solid reason to at least keep the rates at current levels, which means heavy financing costs for individual and corporate borrowers.

Against this backdrop, experts warn that Korea’s asset market will slump further while individuals and companies struggle harder to handle snowballing debt. Financial authorities have to undertake proactive policies to help the debt-laden groups and to minimize the adverse effect of high interest rates on the financial market.