Bank of Korea sets stage for tightening after holding rates

South Korea’s central bank chief sent a strong indication of tightening later this year after the Bank of Korea (BOK) left its monetary policy unchanged on July 15.

The BOK kept the benchmark interest rate at 0.50%, given the sustained uncertainties related to the spread of COVID-19.

Governor Lee Ju-yeol, however, reaffirmed his stance on raising interest rates by the end of the year in a press conference after the rate-setting meeting. A monetary policy board member Koh Seung-beom suggested the benchmark rate should be raised by 0.25 percentage points this month. That was the first rate hike opinion from the seven central bank board members since the COVID-19 hurt the economy.

MORE HAWKISH BOK

Lee sounded more hawkish, saying that the central bank may consider a monetary policy adjustment from the next policy meeting.

“I think the time has come to discuss and review whether the degree of monetary policy easing is appropriate from the August Monetary Policy Committee meeting,” Lee said in the press conference.

The comment raised expectations that the timing of the discussion on an interest rate hike will be brought forward.

On June 11, Lee said the current accommodative monetary policy should be normalized in an orderly manner from an appropriate time. He said on June 24 that it was necessary to raise the benchmark interest rate within the year.

Lee predicted the impact from the fourth wave of the COVID-19 on economic growth this year will not be large, although the central bank is closely watching the situation.

“A recovery in consumption may slow due to tougher social distancing measures, but this year’s growth rate will be around the 4% level,” he said. “A large-scale vaccination is scheduled and the solid trend of exports and investments that have driven growth will continue."

The current negative GDP (Gross Domestic Product) gap will be “resolved” in the first half of 2022, he added. Resolving the negative GDP gap means that the actual growth rate can exceed the potential growth rate.

Lee expressed deep concerns over financial imbalances, including soaring household debt and overheated asset markets.

"If we keep the low interest rate trend for a long time, the side effects of the accumulation of financial imbalances will be greater," he said. "It could weaken the growth base of our economy in the medium to long term."

"Almost every board member agreed that it was time to place our utmost priority in addressing financial imbalances," Lee said.

 HIKE AS EARLY AS AUGUST?

The BOK holds three more policy meetings this year on Aug. 26, Oct. 12 and Nov. 25. Market participants seem to regard a rate hike within the year as a fait accompli.

Lee said he would push for a full-fledged discussion on increasing rates next month while a monetary policy board member Koh suggested a minority opinion of a hike. The central bank usually changes monetary policy in one to four months after a minority opinion is made. Other hawkish members such as Cho Yoon-je and Lim Ji-won are also likely to suggest a hike.

The central bank is expected to raise rates after October as it is necessary to closely watch the economic impact from the fourth wave of the COVID-19, most brokerages forecast. Samsung Securities, NH Investment & Securities and Hanwha Investment & Securities are betting on a hike in October.

Some did not rule out an increase in August.

“If the number of COVID-19 cases falls below 1,000 a day, an August rate hike is possible,” said Kim Sanghoon, a fixed-income strategist at KB Securities. “The benchmark rate will rise 0.75 percentage points to 1.25% at the end of next year.”

Reflecting the hawkish central bank stance, the won strengthened and treasury bond yields rose. The won closed up 0.6% to 1,141.5 against the dollar and the most liquid three-year treasury bond yield gained 10.7 basis points to 1.497%, the highest since Nov. 18, 2019.

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