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[Editorial] Managing inflation and exchange rate is key

Published: 26 Feb. 2023, 20:15

The Bank of Korea’s Monetary Policy Board last week kept the base rate steady at 3.5 percent, pausing the rate increases for the first time since the lifting started in August 2021. The bank made it clear that the pause is “temporary” for a breather after nonstop hikes over the last 18 months. Governor Rhee Chang-yong said that the board has taken the “unprecedented high uncertainties” into account before deciding to take a breather after raising the base rate in every rate-setting meeting from April last year. But the governor warned that the pause should not be understood as the end of high rates. “When the fog is too heavy, it is best to wait until the fog lifts before we drive on,” Rhee said.

Although the central bank chief has made the intention clear, the rate freeze nevertheless could send mixed signals to the market. The market could perceive the central bank as being more worried about an economic downturn than curbing the deepening inflation.

The market indeed has moved in the opposite of the bank’s wishes. Market participants are betting on a winding-down in the tightening cycle in Korea. The chain raise in utility fees has been fanning service charges in diners and elsewhere. The consumer price index rose 5.2 percent year-on-year in January. The expected inflation rate shot above 4 percent in January.

Korea has been scrambling to keep up with the U.S. rate increase to prevent excessive weakening of the Korean won against the dollar, capital flight, and a surge in prices from expensive imports. Still, the rate gap has widened to a 22-year record of 1.25 percentage points with the key rate at 3.5 percent in Korea and 4.5 to 4.75 percent in the U.S.

The rate increases in the U.S. will likely continue. The minutes from the Federal Open Market Committee (FOMC) meeting in February underscored the need to keep fighting inflation. The FOMC is expected to bump up the target range by 25 basis points in March and May to eventually elevate the benchmark rate up to 5.25 percent.

Our financial authorities must not deviate from its focus on controlling inflation just because the base rate has been frozen. The fiscal, monetary and financial chiefs meet every Sunday to tackle the challenge. They must not be divided in the goals for economic management. They must take special care so that the rate decision does not worsen inflation and endanger the exchange rate.