Korea makes bold rate move with one eye on the weak won

Finance

Published: 12 Oct. 2022, 17:29

Korea makes bold rate move with one eye on the weak won

Bank of Korea Gov. Rhee Chang-yong speaks to reporters at the press conference held in central Seoul on Wednesday. [NEWS1]

Korea upped interest rates Wednesday by half a point with more increases promised by the central bank, which noted both inflation and the weak won as being central to its stance.

The "big step" was in line with expectations and brought Korea close to the United States in terms of the cost of money. Korea's base rate, now 3.0 percent, is back where it was in October 2012.

"The board decided today to raise the base rate by 50 basis points in consideration of the need to strengthen its policy response," Gov. Rhee Chang-yong said after the rate announcement. "We judged that upside risk to consumer price inflation, which is expected to persist in the high range of 5 to 6 percent for a considerable time, has increased as a result of the depreciation of the Korean won."

Inflation in Korea hit 5.6 percent in September, and won is down around 20 percent this year. It is at a 13-year low against the dollar.

The vote by the seven-member Monetary Policy Board was five in favor and two against, with the dissenters calling for a quarter point increase. The board “sees continued rate hikes as warranted,” it said in a statement.

Korea’s central bank is in a difficult position as the won weakens and the property market teeters. If it is too dovish, the currency could further weaken and inflation could remain high. If it is too hawkish, bankruptcies could increase and the economy could slow dramatically.

"Between 25 basis points and 50 basis points, 50 basis points was decided on following a lot of discussions," Rhee said.

After the rate increase, the won appreciated, going from 1,435.20 to the dollar Tuesday to 1,424.90 Wednesday.

The board’s Wednesday decision follows a 25-basis-point increase on August 25 and comes three months after Korea's first-ever 50-basis-point increase, on July 13. Almost all analysts polled by Reuters forecast Wednesday's half-point hike.

It is the eighth increase since the central bank started taking rates up last August from a record-low 0.5 percent.

Despite the big step — which is how the Korean press is describing half point increases — the base rate is still lower than the Federal Reserve’s federal funds rate, which was raised by three quarters of a percentage point in September to a range of 3 percent to 3.25 percent. This is the highest since early 2008.

Rhee notes that a 50 basis points increase in Korea is on par with 75 basis points in the United States because most loans are offered with floating rates in Korea.

Following a moderate September jobs report in the U.S., the Fed is expected to raise the rate by another 75 basis points in November. FedWatch, which is run by the CME Group and forecasts rates using Fed Fund futures contract prices, puts the chance of a three-quarter point increase at 80.4 percent.

The unemployment rate in the United States fell to 3.5 percent in September, from 3.7 percent a month earlier.

The rate differential between Korea and the United States could result in capital outflows from local financial markets as investors move funds toward higher returns.

A moderate September job report gave more room for the Fed to further pull up the federal funds rate to tame inflation, according to Kim Sung-soo, an analyst at Hanwha Investment & Securities.

The terminal rate for Bank of Korea’s base interest rate is 4 percent at the end of the first half next year, he added. The terminal rate is where the benchmark interest rate will come to rest before the central bank starts trimming it back.

Rates are set by the Monetary Policy Board eight times a year. Its last meeting in 2022 is scheduled for Nov. 24.

BY JIN MIN-JI [jin.minji@joongang.co.kr]