MNI STATE OF PLAY: Financial Imbalances Drive BOK On Rates

With concern over financial imbalances caused by prolonged low interest rates increasing, the Bank of Korea on Thursday raised its policy interest rate to 0.75% and signalled more to come.

"The Board will continue to conduct monetary policy in order to sustain the recovery of economic growth and stabilize consumer price inflation at the target level over a medium-term horizon, while paying attention to financial stability."

But BOK Governor and Chairman Lee Juyeol said the decision to hike was not unanimous.

The decision reflected the bank's view that the economy will not deviate from a recovery path despite higher Covid-19 cases. The BOK also wanted to curb a weaker South Korean won, although the currency was not mentioned in the statement.

Chances of a rate hike picked up steam this week as the South Korean fell slightly against the dollar. Still, chances of the BOK holding steady were earlier in the market because of concerns about the impact of higher Covid-19 cases.

KOREAN WON FALLS, INFLATION VIEW HIGHER

The dollar traded at around KRW1,165 this week, near the lowest levels this year. The currency weakened further against the dollar after a short-lived jump on Thursday and traded at 1,170.65 around noon, according to Bloomberg data.

Household debts raised the concerns on financial imbalances, along with higher housing prices and inflation. The BOK raised its inflation rate forecast this year to 2.1% from 1.8%.

"Consumer price inflation has remained high at the mid-2% level due to the rising prices of petroleum products and agricultural, livestock, and fisheries products as well as the accelerating increase in service prices," the BOK said.

"It is forecast that consumer price inflation will increase to the lower-2% level this year, exceeding the May forecast of 1.8%. Core inflation is forecast to run at the lower-1% level," it also said.

But the BOK left its real economic growth forecast from May this year unchanged at 4.0%, indicating the South Korean economy has sufficiently recovered to begin raising rates. The GDP forecast in 2022 was also left at 3.0%.

PATH FORWARD

BOK officials will carefully monitor economic and financial conditions after the rate hike as the government has extended its social distancing measures to Sept. 5 from Aug. 23.

"In this process the Board will judge when to further adjust the degree of accommodation while thoroughly assessing developments related to COVID-19, changes in the pace of growth and inflation, the risk of a buildup of financial imbalances, and monetary policy changes in major countries," the BOK said.

The BOK in March 2020 lowered the key policy rate to 0.75% from 1.25% to support the economy as Covid-19 spread, and in May lowered the rate to the historical low of 0.50%.

The next policy-setting meeting is scheduled on Oct. 12.