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Bracing for U.S. rate hikes

Published: 16 Dec. 2016, 19:25

As much anticipated, U.S. interest rates have been lifted. The U.S. Federal Reserve on Wednesday raised short-term interest rates by a quarter of a percentage point, signaling the beginning of a tightening cycle and the end of the ultra-low interest rate era across the globe starting with the world’s biggest economy. Since the financial crisis of 2008, major economies have struggled to stimulate the economy through unprecedented monetary expansion by keeping interest at zero percent or below and inundating the capital market with cheap liquidity.

The unorthodox method has been costly but did the trick for the United States, which has allowed it to start tending to the side effects by redeeming the money through tightening. The U.S. central bank has taken the initiative and European and Japanese counterparts are also beginning to consider tapering-off in their quantitative easing program, a move the U.S. Fed has taken before starting raising interest rates.

Pain is inevitable in deleveraging. The action has long been forewarned, but the local market still took it badly. Stocks, foreign exchange rates, and bond prices all crashed. The finance ministry said it will keep vigilance and take “resolute” actions to stabilize the markets when necessary.

Higher interest rates can trigger the ticking bomb of household debt now hovering at 1,300 trillion won ($1.1 trillion). Because of higher monthly interest rates, consumers would have less to spend. The real estate market that has been the sole driver of domestic demand could slump. The Korean interest rate should rise to prevent foreign capital from leaving the country, but that too is not easy given worsening economic conditions.

The depression in the economy on top of political insecurity calls for further cuts in the base rate. When the Fed made the first quarter increase in a decade in December last year, more than 6 trillion won left Korean markets in the next three months. The Bank of Korea on Thursday kept the policy rate unchanged at a record low of 1.25 percent.

The removal of uncertainties about when the liftoff would take place would help in the near term. But the looming bigger uncertainties will make relief short-lived. The U.S. signaled three more hikes next year. The tightening could come faster than expected because of inflationary pressure from fiscal expansion if Donald J. Trump makes good on his campaign pledges on heavy infrastructure spending. By year-end, U.S. short-term interest rates could be higher than the Korean base rate.

That’s disastrous for the local economy. The Korean central bank cannot easily push up interest rates due to its negative impact on household debt and a sluggish economy. At the same time, it cannot watch foreign capital pull out of the domestic market. The central bank’s hands are tied as U.S. tightening threatens our shore.

The economic team under Deputy Prime Minister Yoo Il-ho will face a test. It must fight off the ill effects by acting as the commander in emergency state. It is the only way the economy can weather the challenges.

JoongAng Ilbo, Dec. 16, Page 34