Rate debate muddier than ever as market offers mixed signals
The Bank of Korea is under pressure to do something at its monetary policy meeting later this week, it’s just not clear what that something should be.
With inflation starting to emerge and people getting squeezed by higher prices, the numbers suggest that the bank should take away the punch bowl. With the economic recovery in its early days and easily snuffed out by overly eager tightening, the numbers also suggest that the bank should hold off on any changes.
The key policy rate has been at 0.5 percent since May last year. Throughout the pandemic, it has been stuck at that record low.
Now, the global economy is starting to rebound, and central banks around the world are contemplating a return to normal.
The Korean economy is now as large as it was before the pandemic started, with GDP rising above fourth quarter 2019 levels. It grew 1.8 percent in the first three months of 2021 on year.
That was the first positive growth since the first quarter of 2020.
Exports have been growing year-on-year since November, last month hitting 41.1 percent, the fastest growth in a decade. It also marked the second consecutive month in which export exceeded $50 billion.
With favorable economic data, President Moon Jae-in has promised 4-percent growth this year, which would be the fastest since 2010’s 6.8 percent.
With the rapid economic recovery, the inflation rate has been rising fast.
In April, prices were up 2.3 percent on year, the fastest increase in four years, with the exception of a 2.5 percent rise in August 2017. It was also the first time since November 2018 the figure was above 2 percent.
Some forecasts put the May rate at above 3 percent, which far exceeds the central bank’s 2-percent inflation target.
Commodity prices have been rising for materials used in the manufacturing of high-tech products on which Korea is heavily dependent for export income, including semiconductors, smartphones and EV batteries.
The price of copper rose as high as $10,537 per ton on the London Metal Exchange. This is a record and double the value just a year earlier.
More expensive commodity prices could hit Korea hard, which is heavily dependent on exports.
Korea’s producer prices rose for six consecutive months through April. Producer prices were up 5.6 percent on year. It’s the sharpest rise in nearly a decade.
Inflation has become a new risk factor, prompting governments to consider pulling back on the massive liquidity they have poured into the market during the pandemic.
On May 4, U.S. Treasury Secretary Janet Yellen commented that a “modest” increase in interest rates is possible after hefty stimulus packages.
“Even though the additional spending is relatively small relative to the size of the economy, it could cause some very modest increases in interest rates,” the U.S. secretary said on May 4.
Financial markets took a hit after news that the U.S. Federal Reserve in its April meeting hinted of possible tapering amid inflation concerns.
Treasuries yields rose.
The European Central Bank (ECB) in its financial stability report released last week raised concerns over insolvencies triggered by massive debts in the Eurozone.
According to the report, the Eurozone government debt-to-GDP ratio rose to 100 percent last year from 86 percent in 2019.
In the report, ECB Vice President Luis de Guindos noted that “the pandemic will leave a legacy of higher debt and weaker balance sheets, which – if unaddressed – could prompt sharp market corrections and financial stress or lead to a prolonged period of weak economic recovery.”
On Friday, ECB head Christian Lagarde said it was “far too early” to discuss its bond purchase scheme.
So far, the Korean government has maintained a stance in which it believes inflation is manageable.
During an economic minister meeting a week ago, Finance Minister Hong Nam-ki stated that the government will continue to closely monitor potential external risk factors, including global inflation and foreign investment.
Analysts see the central bank maintaining its course. If any changes are to be made, they are likely to come in the second half.
“It’s likely that the monetary policy committee will vote to unanimously hold rates steady,” said Lee Mi-seon, a Bookook Securities analyst. It’s likely that the committee will maintain the current loose monetary policy emphasizing ongoing Covid-19 uncertainties despite the adjustment on the economic forecast.
The analyst noted that while there is interest in the U.S. central bank’s tapering, the Federal Reserve is still seen holding steady.
“For the argument on tapering to gain some strength, recovery in both employment and inflation should be absolute,” Lee said.
The United States added 266,000 jobs in April, according to the U.S. Labor Department, which was far below market forecast. It was even less than March’s 770,000.
The Bookook Securities analyst said Korea’s own discussions on raising interest rates will likely start when the country achieves herd immunity and better job numbers.
Seo Jung-hun, a Samsung Securities analyst, said the recent inflation shock has been waning and unlikely to effect the central bank’s decision.
“Since the April’s inflation surprise, it seems that concerns are waning,” Seo said. “U.S. 10-year treasuries have stabilized, while the raw material prices, which has been affecting producer prices, have taken a breather.”
The analyst said some of consumer product prices have been dropping.
“Adding all of this data, one could assume that consumer demand has not recovered enough to embrace the high inflation,” Seo said. “It’s likely that the inflation momentum has de-escalated.”
Commodity prices are also showing signs of stabilizing, with copper falling to $10,011 per ton.
BY LEE HO-JEONG [email@example.com]