BOK takes ‘baby step’ to combat inflation and slowing growth

The Bank of Korea’s (BOK) Monetary Policy Board took a ‘baby step,’ raising the base interest rate by only 0.25 percentage points on Thursday. It has been only a month since it made an unprecedented ‘big step,’ a half percentage point increase in interest rates, in July. The Board’s four consecutive rounds of increase brought the rate to 2.5 percent per year. “We will maintain our stance of raising the base rate by a quarter percentage point at a time for a while,” BOK Governor Rhee Chang-yong said.

After the Board meeting, the central bank hiked its projection for this year’s consumer price inflation rate by 0.7 percentage points and lowered the economic growth rate by 0.1 percentage points. This means that even though both inflation and economic outlook, for now, paint grim pictures, the first is a bigger concern. Above all, the failure to rein in the soaring inflation at a right time will lead to a vicious cycle where overall consumption and investment slow down.

In the face of an urgent need to curb the rising inflation, there is doubt on whether a ‘baby step’ can keep the inflation under control. The inflation rates in June and July hovered over the 6 percent mark, heading toward the worst scenario since the Asian Financial Crisis. It is highly likely that the energy price may go up again with the end of the year drawing near. Taking a ‘baby step’ doesn’t mean that the economy will necessarily pick up, amid investment, consumption, and export are all seeing a downward trend. The monetary policy neither bold nor decisive will be just chasing two hares of inflation and economic growth but catching nothing.

In September, the U.S. Federal Reserve System (FRS) will make its decisions on whether to give another boost to the benchmark rate. If the FRS chooses to make a giant step of raising the monthly base rate by 0.75 percentage points, the country’s base rate will stand between 3.0 and 3.25 percent, prompting the reversal of interest rates between Korea and the U.S. The won/dollar exchange rate reached the highest level in 13 years and four months since the global economic crisis of 2008-2009. This is because global economic uncertainties led investors to rush to the U.S. dollar, a safe asset. If the two nations’ interest rates reverse, Korea can face a full-scale capital outflow.

“Inflation will be at its peak in September or October and turn downward since then,” said Finance Minister Choo Kyung-ho in such a difficult situation. “The peak of inflation may be brought forward,” the minister said on Thursday. The BOK is not considering a big step for the time being.” Many now overtly say that there is no need to worry about capital outflows. The authorities seem to be in too much optimism when it is not even enough to assume the worst scenario and put forth monetary and financial policies accordingly. There may be a long way to go to stabilize the price and exchange rate.