MNI STATE OF PLAY: S. Korea Cenbank To Hike To 1.75% On Prices

The Bank of Korea is expected to raise its policy interest rate to 1.75% from 1.50% on Thursday, putting its top priority on curbing inflation over concerns of a slower economy, observers said.

“A 25 basis point rate hike is expected this week, although the new governor indicated a 50 basis point rate hike,” Kota Hirayama, senior economist in charge of emerging economies at SMBC Nikko Securities, said. In his first policy review as governor, Rhee Chang-yong had made it clear in his confirmation that he is focused on inflation, but he has said he is flexible on monetary policy direction.

Hirayama also said the focus on prices comes against concerns on slow growth in China, a key trading partner. “Unless the economy contracts and the labor market situation worsens sharply, the bank’s stance of curbing inflation rate will not change,” he added.

INFLATION

South Korea's consumer prices jumped 4.8% y/y in April to the highest since October 2008, with May inflation data, due on June 3, a wildcard for the pace of a second straight hike, See: MNI STATE OF PLAY: South Korea's Cenbank Focused On Inflation.

Hirayama said that the BOK may consider a 50 basis point rate hike if it estimates inflation will surge further in the May data.

As well, the Korea Development, a Korean government agency, on May 18 recommended the BOK raise the policy interest rate as consumer price index this year is expected to rise above 4%.

“Macroeconomic policy needs to gradually normalize monetary accommodation in light of the pace of recovery and simultaneously, tame high inflation and ballooning sovereign debt,” the KDI said. “Monetary policy should slowly raise the base rate to keep the expected inflation within the target range.” The BOK targets inflation around 2.0% over the medium term.

The KDI raised its inflation forecast this year to 4.2% from 1.7% in November 2021 and lowered its GDP forecast to 2.8% from 3.0%.

CURRENCY TOO

“The BOK will likely raise the policy rate on the back of the high inflation rate and amid concern over a weaker currency," according to a person familiar with the BOK's policy views. The Korean won weakened to 1,288.50 against the USD on May 12, but has since recovered slightly to around KRW1,270.70 on Monday.

Another factor for the currency is the expected pace of hikes by the U.S Federal Reserve this year, particularly if it accelerates tightening. Rhee has said that he is paying attention to the Fed as an at least 50 basis point hike is expected at the next meeting, raising concerns over capital outflow from the financial markets and the Korean won's further depreciation against the USD.