Bracing for a rate hike

The United States is beginning to roll back its ultra-loose liquidity pipeline. The Federal Reserve has declared the start of tapering or gradual winding down in the massive bond purchase program that it had carried out to support the economy amid the pandemic crisis. The process will involve a $15 billion monthly reduction from the current $120 billion a month the Fed is currently buying.

Fed Chair Jerome Powell said that the purchases could be adjusted depending on the economic performance and outlook. The global stock markets stayed relatively calm from the signal that the Fed won’t rush to the tapering. But once the bond purchase program normalizes, the Fed will be ready to lift its benchmark rate.

Market yields have already been rising sharply. The pace of the rate increase hinges on inflation.

Bloomberg observed that tapering has been initiated on the judgment that the supply imbalance in key U.S. industries could last longer than expected. Experts are mixed about inflation prospects. Some think inflation would be short-lived while others warn of stagflation. But pessimism has gained further grounds with little sign of easing in soaring raw material and consumer prices.

If inflation keeps up while the economy moves in slow motion, stagflation could arise. The Fed is expected to reduce its bond purchases for eight months until the first half of next year before starting to raise benchmark rates from the latter half. The Fed’s rate target has stayed at 0 to 0.25 percent since March last year.

The local bond market has been responding in panic, the benchmark three-year government bond yield has soared 50 percent from three months ago while the mortgage loan rate has jumped to 5 percent. Consumers who have sought loans to buy a home are alarmed. As household debt has already exceeded 1,800 trillion won ($1.5 trillion), higher rates could tick off the snowballing household debt bomb. Individual insolvencies are inevitable if borrowers cannot afford interest payment, which will lead to risks for banks.

The consumer price index gained 3.2 percent on year in October, the fastest in nearly a decade.

The Bank of Korea may have to raise its base rate again to control inflation. Authorities must ready all possible protection so as not to unsettle households. Lenders will also have to brace for the landing from an ultra-loose period.