Bank of Korea’s Rhee Warns of Slower Growth After Outsized Hikes
Bank of Korea Governor Rhee Chang-yong acknowledged the difficulty of sticking with outsized interest rate hikes to battle inflation and support the currency after the central bank’s latest move prompted dissent within his board.
(Bloomberg) — Bank of Korea Governor Rhee Chang-yong acknowledged the difficulty of sticking with outsized interest rate hikes to battle inflation and support the currency after the central bank’s latest move prompted dissent within his board.
The South Korean central bank narrowed the policy gap with the Federal Reserve earlier Wednesday by raising its seven-day repurchase rate by a half-percentage point to a 10-year high of 3%, as expected by 16 of 19 economists surveyed by Bloomberg. The remaining three had forecast a quarter-point move.
Two board members voted against the decision as concerns over slowing growth and a downturn in the property market fueled renewed caution over the central bank’s policy trajectory.
“There’s a lot of disagreement over the pace of the November hike among board members,” Rhee said, adding that the decision will heavily depend on coming moves by the Fed.
The BOK is the latest central bank to respond to the Fed Chair Jerome Powell’s doubling down on large rate hikes to try to crush inflation. The BOK’s potentially brief return to a faster pace of tightening underscores the urgency to counter capital outflows that have sent the won to its lowest levels in 13 years since the Fed made clear it would raise rates higher and for longer.
US rates were a full percentage point below the policy rate in Korea back in early March, but are now higher even after the latest BOK move.
Rhee’s comments point to the awkward balancing act for his and many other central banks across the globe that are trying to engineer a soft landing from the inflation fight without letting their currencies collapse.
“The foreign exchange volatility around the world depends heavily on expectations for a stronger dollar,” Rhee said. “International financial markets have been shaken by the pace of tightening in the US, but they could also turn around sharply if the US stops raising rates.”
The possibility that the won could suddenly strengthen should a global downturn prompt the Fed to stop its policy tightening appeared to help the won despite the likelihood of a slower pace of rate hikes by the BOK going forward. The won strengthened by as much as 0.7% to 1425.20 against the dollar after Rhee’s comments.
Rhee warned retail investors of losses overseas should the won reverse in one or two years, encouraging them to bring back their money to better-yielding financial accounts at home.
“Rhee diligently defended the won by saying things like investors should mull changing their foreign investment strategies, and that the won is not the only currency weakening globally — all of which should offer some relief for the currency,” said So Jaeyong, an economist at Shinhan Bank.
But the effect is likely to be short-lived as there’s much uncertainty left and as the main driver for markets remains overseas, he added.
The depreciation of the won is exacerbating inflation in Korea, which relies heavily on imports of energy and other essential items. The currency was largely unchanged from its level immediately before the widely expected decision. The nation’s three-year bond yield extended its drop following the press conference, falling 22 basis points to 4.12%.
Rapid policy tightening by the Fed on top of mounting global growth concerns have weighed on emerging Asian currencies. The won remains the worst performing currency in Asia next to the yen this year. A slowdown in Korean exports and dwindling foreign reserves are adding to bearish sentiment for the currency.
Earlier in the day, the bank made clear that borrowing costs would continue to go up even as growth for the coming year was expected to undershoot its earlier projections.
“The Board sees continued rate hikes as warranted, as inflation is expected to remain high, substantially above the target level, although domestic economic activity has slowed,” the central bank said in a statement. The economy is expected to grow next year at a slower pace than an August forecast of 2.1%, it added.
“We recognize that there’s very high uncertainty and if the downside risk materializes to the global economy, Korean growth will suffer,” Martin Kaufman, mission chief for Korea at the International Monetary Fund, told Bloomberg TV after the decision. He added the BOK has been “quite nimble” and “not shy” to use rates to fight inflation.
The worry for policymakers is that rising consumer prices will spur workers to demand higher pay, potentially unleashing a wage-price spiral.
Swap markets are now pricing in just one more quarter-point rate hike in the next three months following Rhee’s comment that the board expected rates to be around 3.5% at the end of the tightening cycle.
The BOK has been concerned that higher rates may increase the strains on households that have built up a record amount of debt and tip the economy into recession. That’s a concern shared by other central banks and institutions such as the IMF.
Rhee said a larger 75 basis point move was ruled out at Wednesday’s meeting over concern over the impact on people with housing loans. Already the property market prices have slipped up to 4% so far this year, Rhee said.
Still some pain and the sacrificing of some growth in the economy was worth it to succeed in the battle against prices, the governor said.
“A property correction via rates is painful but contributes to stability for the overall macro economy,” Rhee said.
(Updates with comments from Rhee)
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