MNI BOK WATCH: Hikes to 3.50%, But Flags Caution Ahead

The Bank of Korea on Friday raised its policy interest rate by 25 bps to 3.50%, maintaining its resolve to tame inflationary pressures, but signalled further hikes will be considered with greater caution as downside risks to the economy grow.

The central bank's move was largely in line with expectations (MNI BOK WATCH: 25bp Hike Expected, Tightening Pause On Radar).

Two policymakers, Joo Sangyong and Shin Sung Hwan, voted against the decision to raise the Base Rate by 25 basis points, proposing to maintain the Base Rate at the current level of 3.25%, the BOK said.

In its statement, the BOK said it would judge whether the Base Rate needs to rise further "while thoroughly assessing the economic downside risks and financial stability risks, the effects of the Base Rate raises, the pace of inflation slowdown, and monetary policy changes in major countries."

FIFTEEN-YEAR HIGH

The bank has raised the policy interest rate at seven consecutive meetings by a cumulative 300 basis points since it began its tightening sequence in August 2021. The policy rate is now at the highest level since December 2008.

BOK Governor Rhee Chang-yong underlined the board's dilemma, saying CPI “is projected to run above the target level for a considerable time, although the GDP growth rate for this year is expected to be below the November forecast.”

“Consumer price inflation remained high, at 5.0% in December... Core inflation has declined slightly to 4.1% and short-term inflation expectations of the general public decreased to 3.8% in December, but they are still at a high level.”

“Going forward, consumer price inflation is projected to be around 5% in January and February. The annual consumer price inflation for 2023 is expected to be generally in line with the November forecast of 3.6%,”Rhee said, but acknowledged the high degree of uncertainty.

The BOK will face tough policy decisions ahead, balancing a high inflation rate, slower economy and a weaker currency largely caused by a widening interest rate gap between the U.S. and South Korea. The interest rate gap narrowed to 1% from 1.25% as a result of the Friday’s rate hike but is set to widen again as the Fed is set to raise the federal funds rate by either 25 or 50 basis points on Feb. 1.

WEAKER ECONOMY CONCERN

Korea's economy "has continued to slow. Exports dropped sharply due to a slowdown in major trading partners’ economies and in the IT business,” Rhee said and will likely be below the November forecasts. However, he pointed to hopes of a recovery in the second half of the year, helped by a pick-up in China, although risks remained.

“With the domestic economy continuing its slowdown, the GDP growth for this year is expected to be below the November forecast of 1.7%. The economy is projected to improve gradually going into the second half of this year, driven by recoveries in the Chinese economy and in the IT business,” he said.

The next meeting is scheduled for February 23.