Bank of Korea Hikes Again as Inflation Fears Mount, Fed Gears Up

© Reuters.

(Bloomberg) — The Bank of Korea raised interest rates on Friday for the third time since the summer, underscoring the board’s determination to swiftly curb inflation and financial risks, and its belief that the economy can weather virus outbreaks with less central bank support.  

The quarter-percentage-point increase to 1.25% brings the rate back to where it was before the pandemic struck. The decision was expected by 14 of 19 economists surveyed by Bloomberg. The rest forecast a hold. 

Bond futures fell as the monetary policy statement suggested rate hikes will continue. The BOK said in a statement that it expected inflation to stay in the 3% range “for a considerable time.” That view is in stark contrast to its stance in November and an indication of how price concerns have ballooned since then.  

The rare back-to-back rate hike likely indicates that Governor Lee Ju-yeol had become increasingly uncomfortable about waiting to move again, following recent signs that the Federal Reserve will probably raise borrowing costs earlier and more aggressively. 

An easing of daily Covid infections from a recent peak in December also helped create a window of opportunity that Lee was apparently keen to take before the end of his term in March and a presidential election the same month. Government plans for an extra budget indicate there will be continued fiscal support for the economy, adding to the case for a hike.

The rate decision shows that the BOK saw omicron’s economic impact as limited and was concerned the variant will likely add upward pressure on inflation, said Cho Yong-gu, a fixed income strategist at Shinyoung Securities. 

“Financial imbalances are yet to be fully resolved, and the Fed bringing forward its tightening timing was also likely a factor,” Cho said.

Moving Ahead 

Korea’s 10-year government yields rose three basis points to 2.43% on Friday, following the BOK’s inflation forecast and as Finance Minister Hong Nam-Ki said the extra budget will be funded by bond issuance. The won was little changed at 1,188.40 as of 10:37 a.m. in Seoul. 

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 has said that the BOK doesn’t need to match the Fed on rate hikes, but no action taken this quarter despite the hawkish signals from the Fed could have unsettled financial markets expecting rate increases.

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. 

While the Korean central bank largely justified its initial rate hike in August as a move to avoid financial imbalances building up from prolonged stimulus, it has since added its concern over rapid price growth into the mix. At 3.7%, inflation is hovering near a decade-high, providing a key motive for early action. 

Faster Inflation 

In Friday’s statement, the BOK said inflation will average above the mid-2% level this year, higher than the 2% it forecast in November. The bank still expected economic growth of around 3%. It added the board will judge when to further adjust policy accommodation, indicating more tightening ahead. 

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. 

Attention now will turn to whether the BOK can continue to raise rates at such a pace — three times in five months — or whether there will be a lengthy hiatus before the next move. 

Lee has repeatedly characterized the rate hikes since August as a backing away from extraordinary stimulus rather than a tightening of policy. With rates back at pre-pandemic levels, the BOK may now move at a slower pace over the coming months, a view shared by economists.  

(Updates with BOK’s policy statement.)

©2022 Bloomberg L.P.


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