SEOUL: The Bank of Korea’s (BoK) return to outsized interest rate increases comes with a warning of slower growth as it sought to shore up a currency that has been driven to crisis-era lows by the US Federal Reserve’s (Fed) aggressive policy tightening.
The South Korean central bank raised its seven-day repurchase rate by a half- percentage point to a 10-year high of 3% yesterday, as expected by 16 of 19
economists surveyed by Bloomberg. The remaining three had forecast a quarter-point move.
“The board sees continued rate hikes as warranted, as inflation is expected to remain high, substantially above the target level, although domestic economic activity has slowed,” the central bank said in a statement after the decision. The economy is
expected to grow next year at a slower pace than an August forecast of 2.1%, it added.
The BoK is the latest central bank to respond to the Fed’s doubling down on large rate hikes to try to crush inflation. The BoK had already increased its rate by a half-point in
July, before downshifting to a quarter-point move in August amid concerns over the impact of larger rate hikes on the wider economy.
The BoK’s return to a faster pace of tightening underscores the urgency to counter capital outflows that have sent the won to its lowest levels in 13 years since the Fed made clear it would raise rates higher and for longer.
US rates were a full percentage point below the policy rate in South Korea back in early March, but are now higher even after the latest move.
BoK governor Rhee Chang-yong is set to explain the reasoning behind the decision at a regular post-decision press briefing.
“Rhee will likely leave the door more open for another 50 basis point hike, after his previous comment preferring a gradual pace of tightening turned out to be misleading,”
said Roh Hyun-woo, a strategist at Hanwha Asset Management. “It’s a painful and worrisome hike but an unavoidable one, too.”
The depreciation of the won is exacerbating inflation in South Korea, which relies heavily on imports of energy and other essential items.
The currency was largely unchanged from its level immediately before the widely
expected decision. The nation’s three-year bond yield fell as much as three basis points to 4.31%.
Rapid policy tightening by the Fed on top of mounting global growth concerns have weighed on emerging Asian currencies.
The won remains the worst performing currency in Asia next to the yen this year. A slow down in South Korean exports and dwindling foreign reserves are adding to bearish sentiment for the currency.
“Any hawkish comments by the BoK governor could potentially strengthen the won more, but that’s likely to be temporary,” said Kim Yumi, a market strategist at Kiwoom Securities, before the central bank’s rate decision.
“The currency may drop further into the year-end as the US dollar is expected to remain strong, and as exports slow down.”
Despite the weakness in the won, the consumer price index eased slightly in
September, though it remained in the 5% to 6% range that Rhee said warrants further policy tightening.
Prices excluding oil and agricultural products also accelerated, adding to concerns about prolonged inflation.
The worry for policymakers is that rising consumer prices will spur workers to demand higher pay, potentially unleashing a wage-price spiral.
At the same time, continued resilience in consumption and low unemployment are among factors giving the BoK confidence that the economy can withstand more rate hikes.
Swap markets are currently pricing in two more quarter-point rate hikes in the next three months.
Still, the BoK has been concerned that higher rates may increase the strains on households that have built up a record amount of debt and tip the economy into recession.
That’s a concern shared by other central banks and institutions such as the International Monetary Fund.
“We think the BoK prefers to signal its policy commitment to pursue price stability with a big-step first and take a steady pace thereafter to minimise the shock onto the domestic economy,” Bank of America analysts Kathleen Oh and Chun Him Cheung, wrote before the decision.
Markets will be interested in knowing if any board members disagreed with the outsized hike. Rhee may also provide signals on whether the BoK will maintain the faster-than- usual pace of tightening or return to 25 basis point moves at the next meeting in November. — Bloomberg
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