Low growth rate is the problem

The Bank of Korea (BOK) has been on an unprecedented tightening campaign, raising the base rate by 50 basis points for the first time last week, delivering uninterrupted fourth rate increases as the country experiences the highest inflation in 24 years. The base rate has now reached 2.5 percent. Although it is on par with the 2.25-2.50 percent rate target range of the U.S., the BOK may have to keep up raises as the Federal Reserve is intent to put the rate target at maximum 3.4 percent by the yearend.

Stabilizing prices have become an urgent challenge around the globe. Korea’s consumer price index that rose by more than 6 percent in June against a year-ago period accelerated to 6.8 percent in July. The BOK in its revised economic outlook estimated annual inflation rate at 5.2 percent for this year, which would be the highest since 1998.

Rate increases dampen money flow to cause negative impact on economic growth. Since strong prices are expected to last for some, stagflation may be unavoidable if growth slows at the same time. Korea’s inflation is relatively lower than the levels in the U.S. and eurozone. But as long as the U.S. continues with rate increases, Korean rate movement will be influenced.

The BOK would also have to keep up with rate increases to keep pace with the U.S. As Fed Chair Jerome Powell warned of “some pain” for American households, Korea’s working and low-income class will also have to brace for hardship ahead. Household debt has reached a new peak of 1,869.4 trillion won ($1.3 billion) as of June. The mortgage loan rate is expected to shoot up to 7 percent. Interest burden will increase as the real estate market has entered a slump.

Restrained consumption from higher debt financing burden will also pare growth. The BOK lowered its growth estimate to 2.6 percent for this year and 2.1 percent for next year. If external conditions worsen from a protracted war in Ukraine and the conflict between the U.S. and China, the growth rate could fall under 2 percent.

The slowdown in the Chinese economy could also make matters worse. Trade with China has been incurring a deficit for the third straight month. Fiscal ammunitions are short after the unprecedented stimuli in the last four years. President Yoon Suk-yeol ordered strict management to prevent a currency crisis after the Korean won sank to 1,350 won against the U.S. dollar, the lowest since the 2009 financial crisis. The government must do its utmost to stimulate corporate activity through radical deregulations so that the economy does not run below the potential rate of 2 percent.