Korea’s first ‘big-step’ hike and the greed

The Bank of Korea (BOK) made its first big-step hike beyond the usual quarter of a percentage point. It bumped up the base rate from 1.75 percent to 2.25 percent. A 50-basis point raise is its first. The three consecutive rate increases are also unprecedented. The BOK has had to rush with tightening due to an alarming buildup in inflation. The value of the Korean currency sinking to 1,300 won against the U.S. dollar has been another factor, as it can fuel inflation from higher import costs. BOK Governor Rhee Chang-yong indicated that the benchmark rate can be raised throughout the remaining three meetings of the year.

The unusually bold move by the central bank was widely expected. The consumer price index gained 6 percent in June against a year-ago period, the steepest hike since November 1998 amid the Asian financial crisis. The BOK estimates that the inflation rate will stay above 6 percent over the next few months. The U.S. Federal Reserve has been galloping away with rate increases. The Fed raised the base rate by 75 basis points last month, and could be equally bold at this month’s meeting. The result will place U.S. rates above Korea’s.

Rate increases can contain expectations for inflation. But borrowers must bear with higher interest burden, and consumption could also be damped. Risk management by each economic player has become urgent. Household debt poses a serious danger. Debt has rapidly snowballed during the loose liquidity period under the pandemic. Household debt-to-GDP has already exceeded 100 percent.

Individuals who had sought debt to invest in real estate and stocks could be pushed to the corner. The rollovers in debt of the self-employed and small merchants under relief program for Covid-19 will end in September. The government must navigate a soft-landing of the household debt and find measures to help ease the growing financing burden for the weak class. Financial companies must prepare for debt going sour and manage risks to their assets.

Banks would be tempted to earn easily from the gap between high borrowing rates and low deposit rates. They tend to raise the lending rates faster than saving rates. According to the central bank, the saving and lending rate gap at banks averaged at 2.37 percentage points in May, up 2.05 percentage points from the end of 2020.

In a meeting with bank CEOs last month, Financial Supervisory Service Gov. Lee Bok-hyun pointed out that banks are criticized for their excessive profit-seeking. They must refrain from easy margin profiting and come up with reasonable rates for consumers.