South Korea hikes rates again as inflation fears mount, Fed gears up

Soaring inflation has been ramping up pressure on policymakers to act. PHOTO: EPA-EFE

SEOUL (BLOOMBERG) - The Bank of Korea raised interest rates on Friday (Jan 14) for the third time since the summer, underscoring its determination to swiftly curb inflation and financial risks, and its belief that the economy can weather Covid-19 outbreaks with less central bank support. 

The quarter-percentage-point increase to 1.25 per cent brings the rate back to where it was before the pandemic struck. 

South Korean bond futures fell as the monetary policy statement suggested rate hikes will continue,  with 10-year government yields rising three basis points to 2.43 per cent on Friday. 

The BOK said in a statement that it expected inflation to stay in the 3 per cent range “for a considerable time.” That view is in stark contrast to its stance in November and an indication of how price concerns have ballooned since then. 

The rare back-to-back rate hike likely indicates that Governor Lee Ju-yeol had become increasingly uncomfortable about waiting to move again, following recent signs that the Federal Reserve will probably raise US borrowing costs earlier and more aggressively. 

An easing of daily Covid infections from a recent peak in December also helped create a window of opportunity that Mr Lee was apparently keen to take before the end of his term in March and a presidential election the same month. Government plans for an extra budget indicate there will be continued fiscal support for the economy, adding to the case for a hike.

The rate decision shows that the BOK saw Omicron’s economic impact as limited and was concerned the variant will likely add upward pressure on inflation, said Cho Yong-gu, a fixed income strategist at Shinyoung Securities. 

Moving Ahead 

The latest rate move puts the BOK further ahead of global peers in pulling back from pandemic stimulus settings as an increasing number of central bankers consider the timing of their own actions.

Mr Lee has said that the BOK doesn’t need to match the Fed on rate hikes, but no action taken this quarter despite the hawkish signals from the Fed could have unsettled financial markets expecting rate increases.

Maintaining a premium over US interest rates can help maintain stability in local markets and prevent a further weakening of the won. Finance Minister Hong ordered officials to closely monitor foreign exchange movements on Monday after the currency reached its weakest level since July 2020 last week. 

While the Korean central bank largely justified its initial rate hike in August as a move to avoid financial imbalances building up from prolonged stimulus, it has since added its concern over rapid price growth into the mix. At 3.7 per cent, inflation is hovering near a decade-high, providing a key motive for early action. 

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