Bank of Korea expected to put a pause on next month's policy rate increase

Finance

Published: 23 Mar. 2023, 17:54

Bank of Korea expected to put a pause on next month's policy rate increase

Finance Minister Choo Kyung-ho speaks at a meeting with chiefs of financial organizations in central Seoul on Thursday following the Fed's announcement on a quarter percentage rate increase. [NEWS1]

The Bank of Korea is expected to put a pause on the policy rate increase next month following the Fed’s rate hike Wednesday that matched general market expectations.

If so, it would be the second consecutive time for the Bank of Korea to keep the policy rate unchanged since February.

The Fed policymakers unanimously voted to lift the federal funds rate by a quarter percentage point to a range of 4.75 to 5.00 percent amid the global banking turmoil.

The Federal Reserve was expected to up the rate by 50 basis points before the collapse of the Silicon Valley Bank and Credit Suisse banks. But the projection was revised down to a quarter percentage point, with some projecting the rate to go unchanged.

The Wednesday decision puts the interest rate gap with the Bank of Korea at 1.50 percentage points, the largest since 2000. The Bank of Korea’s policy rate sits at 3.50 percent.

“Inflation remains too high, and the labor market continues to be very tight,” Fed Chair Jerome Powell said at the post-meeting press conference. “We remain strongly committed to bringing inflation back down to our 2 percent goal.”

“The U.S. banking system is sound and resilient,” read the Federal Open Market Committee's statement. “Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring and inflation. The extent of these effects is uncertain.”

“The Bank of Korea likely won’t raise the policy rate at the upcoming meeting,” said Chae Hyuk-ki, an analyst at Heungkuk Securities, citing an unchanged terminal rate estimate and the country’s weak growth. “Before the recent banking turmoil, there were projections the Fed may raise its estimate for the rate peak to beyond 6 percent. But it kept the terminal rate” at 5.1 percent.

“Weak growth due to export slowdown is also pressuring the central bank from raising the rate,” Chae said.

Korea reported $30.95 billion in exports through March 20 this month, down 17.4 percent on year, according to Korea Customs Service. The country reported $47.8 billion in trade deficit last year.

The OECD revised Korea’s growth forecast for this year down to 1.6 percent from the previous 1.8 percent in its interim economic outlook on March 17. The forecast is lower than the estimated 2.6 percent growth for the global economy.

Despite the uncertainties, it is too early to expect a rate cut this year.

“The Bank of Korea is projected to keep the rate unchanged throughout the year unless systemic risks in key countries are created,” said Shin Earl, an analyst at Sangsangin Investment & Securities.

“The central bank may cut the rate if the systemic risks cannot be controlled through government policies, but it would be too extreme a decision for the bank to lower the rate by setting a precondition for the possibility of the risk.”

Federal Reserve Board Chair Jerome Powell speaks during a news conference in Washington on March 22. [AFP/YONHAP]

One key variable that may drive the central bank to up the rate in the upcoming rate-setting meeting is the volatility of the currency exchange rate.

“A primary factor that drove the Bank of Korea to raise the rate last year was the volatility in the foreign exchange rate,” Chae added. “The bank may return to upping the rate if the won weakens to the point of its previous low,” which was above 1,440 won in October.

The won rose 2.25 percent on Wednesday to 1,278.3.

But the sudden volatility in the exchange rate is unlikely, according to Cho Yong-gu, a fixed income strategist at Shinyoung Securities.

“The dollar index fell as the terminal rate remained steady on Wednesday. The strengthening of the euro, following the recent rate increase, also helped.”

The European Central Bank raised the rates by half a percentage point on March 16.

The dollar index fell to 102 against a basket of currencies from mid-105 earlier in the month.

The Bank of Korea “will actively take market stabilization measures if necessary while thoroughly monitoring changes in external conditions and domestic trends in capital flow and price,” including interest rate, stock market and currency exchange rate, said Lee Seung-heon, the senior deputy governor at Bank of Korea on Thursday.

“The possibility of the recurrence of uncertainties in the global market and the expansion of the uncertainties cannot be excluded,” said Finance Minister Choo Kyung-ho in a meeting with chiefs of financial organizations in central Seoul on the same day. The world economy is now “in the process of adjusting to the new environment of intense monetary tightening.”

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