Strong Korea Q2 growth keeps rate hike stance despite COVID-19 risks

South Korea's economy reported strong growth on healthy private consumption in the second quarter, keeping expectations of an interest rate hike later this year intact. But a resurgence in COVID-19 infections has darkened the outlook for Asia’s fourth-largest economy in the coming months.

The economy expanded 0.7% in the April-June period from the previous quarter and 5.9% year on year, the fastest annual pace since the fourth quarter of 2010, data from the Bank of Korea (BOK) revealed on July 27.

Private consumption increased 3.5% in the second quarter, the highest in 12 years, as the rapid vaccination rollout improved consumer sentiment. The service sector grew 1.9%, to mark the highest quarterly growth since the first quarter of 2007.

The central bank said gross domestic product (GDP) rose 3.9% in the first half, higher than its own forecast of 3.7%, helping the economy to grow 4% this year.

“The fourth COVID-19 wave will have a relatively weaker impact on private consumption than the previous waves,” said Park Yang-su, head of the statistics department at the BOK. “The second supplementary budget will also have the effect of pushing up the growth rate."

Lawmakers approved a 34.9 trillion won ($30.2 billion) supplementary budget earlier this month, the largest on record for extra spending outside the country’s annual budget, to help households and small businesses hit hard by COVID-19. In March they had already endorsed an extra 14.9 trillion won to the budget.

After the second-quarter growth data was released, the most liquid three-year treasury bond yield edged up 1.1 basis points to 1.38%, the first rise in three sessions. The healthy growth added to expectations that the BOK will be the first Asian central bank to raise interest rates from pandemic-era lows.

“The interest rates could be increased in August if COVID-19 cases fall below 800,” said Kim Sang-hun, a fixed-income analyst at HI Investment & Securities.

BOK Governor Lee Ju-yeol said on July 15 that the central bank may consider a monetary policy adjustment from the policy meeting in August, fanning speculation of tightening later this year.

LOOMING RISKS FROM DELTA VARIANT

Meanwhile, COVID-19 infection cases have remained stubbornly high in the four digits for three consecutive weeks, reaching a record high of 1,842 on July 22. The government implemented its toughest restrictions yet to contain the pandemic, which some analysts said will hurt consumption.

“Private consumption, which accounts about a half of GDP, will significantly shrink as the Level 4 social distancing curbs continue until next month,” said Joo Won, chief economist at Hyundai Research Institute, referring to the strictest measures, which include a ban on gatherings of more than two people after 6 p.m., in the capital Seoul and neighboring areas. “A contraction in the third quarter cannot be ruled out.”

Finance Minister Hong Nam-ki said in a Facebook post said a recent surge in COVID-19 infections and extended distancing rules are expected to pose a threat to an economic recovery, although the economy remains on track to achieve 4% growth this year.

A spread of the Delta variant around the globe is another risk as restrictions of other countries could hit exports. Overseas sales in the second quarter already skidded 2% on weaker automobile shipments amid the global automotive chip shortage.

Goldman Sachs slashed its forecast for US economic growth for this year to 6.6% from 7% amid a recent resurgence in COVID-19 infections via the Delta variant.

Write to Ik-Hwan Kim at lovepen@hankyung.com
Jongwoo Cheon edited this article.