The two faces of low interest rates

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The two faces of low interest rates

Published: 08 Aug. 2024, 19:57

Kim Dong-ho
The author is the business news editor of the JoongAng Ilbo.

The high interest rates that have weighed down the global economy are poised to come to an end. Inflation — the key to lowering the benchmark rate — is finally calming down. The U.S. consumer price index (CPI) in June was 3.0 percent, sharply lower than 9.1 percent in June 2022. The chairman of the U.S. Federal Reserve Jerome Powell said he had a greater confidence for the CPI to descend to the 2 percent range.

The rate cut is more urgent in the United States due to the recession fears that rocked global stock markets in the last few days. Analysts attribute the scare to the Fed’s dillydallying on lowering the benchmark rate to control inflation. The unemployment rate actually rose to 4.3 percent in July. As a result, some analysts predict the Fed will make a big cut of 0.5 percent next month.

Following the U.S., Korea is expected to cut its benchmark rate as early as October. The Bank of Korea Governor Rhee Chang-yong said, “The time has come to be prepared to change lanes and shift direction.” Korea’s benchmark rate at 3.5 percent is even lower than the United States’ 5.25-5.5 percent. The high exchange rate hovering at nearly 1,400 won per the dollar as a result of the rate gap has been a cause of considerable instability in the Korean economy.

The tide is clearly turning. But it’s worth remembering that even if the U.S. pivoting begins in full force starting September, the long-term ultralow rate era will not come again, as it did before March 2022, when the Fed started raising the rates. Major central banks have thoroughly confirmed the adverse effects of the ultra-low interest rate.

The ultra-low rate system went extreme in Sweden in 2015 in the form of negative rates. It was to stimulate the economy, but debt exploded along with inflation. Adding fuel to the real estate market led to economic instability and widened a gap between the rich and the poor. Japan, the origin of the ultralow interest rate, also introduced negative rates in 2016, but they ended in complete failure. After suffering a super-low yen trend, the Bank of Japan raised the benchmark rate to 0.25% last month.

At a time when interest rates are falling again, it is important to remember the two faces of a rate cut. It is positive that when interest rates fall, the pain from high rates will be immediately eased. But at the same time, many people can be tempted to borrow money at lower rates. This means a rate cut could be both a medicine and a poison. It is especially problematic as a rate cut can stimulate prices as liquidity increases. Korea’s household debt is already among the world’s highest for its GDP size.

U.S. Republican presidential candidate Donald Trump expressed his view that the Fed should not lower the rates before the November presidential election. But it is still unclear whether the CPI — the key to the pivoting — will actually fall to the 2% range. In June 2023, the CPI dropped to 3.0%, but since then, U.S. prices have remained sticky.

It has become urgent to cut the rates to eliminate fears of recession, but what if the CPI does not fall below the 2 percent level? Even if the pivoting starts, the rates may not fall drastically. But the mood for borrowing money is already heating for the expectations for rate cuts. The real estate market is reacting fast. As the possibility of pivoting grows, mortgage loans are swelling fast.

But you should not forget the high rates from 2022 to 2023. Even if the pivoting starts this time in Korea, it’s difficult to go to ultralow interest rates. Moreover, if housing prices become unstable as they are now, interest rates can rise again at any time.

It should also be taken into account that even if housing prices rise, not much profit can be pocketed after paying gift and inheritance taxes that are among the highest in the world. Although the tax code revision bill increased children exemption tenfold to drastically expand the inheritance tax exemption in 2024, it’s unclear whether it will be passed by the legislature.

If the rates fall, it would be great as an opportunity to buy a house for oneself, but nothing more than that. We must not forget the two faces of low interest rates.