The BOK raises its key rate to 0.75% l KBS WORLD
The Bank of Korea or BOK raised its key rate to 0.75% on August 26 from 0.5%. This is the first time in 15 months that the central bank’s monetary policy board has changed the interest rate. It is also the first time since November 2018 that the BOK has raised its key rate. The rate hike signals an exit from the “ultra-low rate policy” that the bank has maintained to effectively respond to the COVID-19 pandemic and stimulate the economy. While some emerging economies, including Brazil, have raised their key rates this year, Korea is the first major Asian economy to do so.
Meet Kim Dae-ho, director of the Global Economic Research Institute, to examine the background to the BOK’s rate hike and its potential impact on the local economy and finances.
One of the reasons for the rate hike is increasing inflationary pressure. Consumer prices rose 2.6% year-on-year in July, exceeding the government’s inflation target of 2%. In addition, the trend of low interest rates has prompted many Koreans to take out loans to invest in real estate and stocks, raising concerns about an asset price bubble and the increase in the market. household debt.
To fight rising inflation, stabilize asset prices and curb household debt, the BOK has decided to increase the primary focus on a major policy change, although this decision may weigh on small businesses. companies.
Household debt in Korea reached over 1.8 quadrillion won, or about 1.6 trillion US dollars, at the end of the second quarter of the year. This is the highest to date since the relevant data began to be compiled in 2003. Another factor behind the rate hike is confidence in the Korean economy, which is expected to grow by more than 4% this year thanks to robust exports. In addition to these internal issues, there are also external factors that influenced the BOK’s decision to raise rates.
The minutes of the US Federal Open Market Committee meeting show that the Fed will soon start to shrink. The United States has also seen an increase in house prices, inflation and household debt. Against this backdrop, the Fed hinted that it would reduce the pace of asset purchases. The US dollar has strengthened over the past month, causing the Korean won exchange rate to rise against the US dollar. South Korea raised its interest rate ahead of the United States, in an apparent attempt to reduce exchange rate fluctuations resulting from the Fed’s potential cut. If the United States increases its key interest rate, funds will flow to the United States from all over the world. Since Korea has already raised its own rate, part of the funds could come to Korea. This is why the BOK proceeded with a preventive rate hike.
Following the rate hike in Korea, borrowers will have to bear a heavier burden of debt repayment. The situation is worrying if we consider that 73% of household loans are at variable rate and not at fixed rate. This means that many indebted households are vulnerable to rising interest rates.
South Korea’s debt, including households, businesses and the nation, stands at 5 quadrillion won, or some 4.3 trillion dollars. In this situation, a rate hike of 25 basis points would translate into considerable gains on the interest payments on the debt. Unfortunately, many self-employed people are already struggling to repay their loans and pay their rent due to strict social distancing rules. These groups will face an even greater burden. For companies that export their goods, rising interest rates will cause them to lose price competitiveness.
Many analysts predict that rising rates will not immediately curb the surge in household debt and house prices. Indeed, many households still need to obtain loans for a variety of reasons, while expectations of rising asset prices are still high enough to offset the growing interest burden resulting from rising interest rates. 0.25 percentage point.
But others say we have to wait and see the effect of the recent rate hike, as the rate decision sent a clear signal to economic players that the era of ultra-low interest rates is over. In addition, additional rate hikes are planned.
BOK Governor Lee Ju-yeol has spoken strongly of the possibility of further rate hikes. But he said the central bank would consider when and how much to adjust rates taking into account various factors, including the development of the pandemic situation and vaccinations. Another big factor would be monetary policy changes in the United States, which are expected to raise their interest rates next year. If the United States starts declining sooner than expected, Korea will be in a hurry to raise its own rate. If the United States slowly hikes rates, Korea will follow suit.
Clearly, Korea and the United States are heading for monetary tightening.
After the end of the global financial crisis in 2010, the BOK raised the interest rate five times in the space of just one year. He could take similar action when the COVID-19 crisis is over. The Korean government and financial authorities must now devise measures to ensure a soft landing for the market in an era of higher interest rates.
Most economists agree that rate hikes are inevitable in light of macroeconomic conditions and the global economic situation. But even though Korea’s economy is improving overall, some businesses have already been hit unexpectedly by the pandemic. In addition to rate hikes, financial authorities must adopt appropriate measures to address the problems of distressed groups, such as delayed loan repayments.
It is also important to raise the interest rate little by little so that the market can prepare for the change. When formulating monetary policies, financial authorities should take into account households and small traders exposed to the risk of rising interest rates. For example, a new policy may allow these vulnerable groups to switch from variable rate loans to fixed rate loans.
In the process of overcoming the pandemic and normalizing the economy and finances, the government, financial authorities and the central bank should be able to come up with thoughtful policies in cooperation to minimize the negative impact of the pandemic on groups. vulnerable. .