U.S. Interest Rates Could Soon Be Higher than Korea’s

On May 3 (local time), the U.S. Federal Reserve Board (FRB) raised the base interest rates from 2.75 percent per year to 3.0 percent by 0.25 percent. As the gap between the U.S. base rates and Korea’s overnight rates (3.25 percent) narrowed by 0.25 percent, there are growing concerns that the narrowed gap could lead to possible capital outflow from Korea. Shyn Yong-sang, a researcher at the Financial Supervisory Commission, has said, “Higher interest rates result from a sluggish economy,” adding that “a sluggish U.S. economy might damage Korea’s export to the U.S.”

Why Did the U.S. Raise Interest Rates? –

The FRB announced in a statement that “Energy price increases dampened the speed of consumer spending, but in the past few months, inflationary pressure is amounting,” expressing concerns over price instability. This is interpreted to mean that higher base rates focused on restraining inflation instead of economic progress. The FRB later added in its statement, “Long-term inflationary pressure is well under control.”

Would the U.S. Interest Rates Rise Higher than those of Korea? –

Since June of last year, the U.S. has raised interest rates a total of eight times, increasing annual base interest rates from 1.0 percent to 3.0 percent within a year. By contrast, Korea’s call rates dropped from 3.5 percent to 3.25 percent in last November, and there has been no change for five straight months. The prevailing argument has been that the U.S. base interest rates would rise for the time being. Economists think that it is just a matter of time until the U.S. interest rates are higher than Korea’s. Park Seung, Governor of the Bank of Korea, said on May 7, “There is a possibility of narrowed gap between the interest rates of the U.S. and Korea, and if the U.S. interest rates rise higher, the problem would be the big gap between the two.”

Concerns over Possible Burden on the Economy –

If the U.S. interest rates rise higher than Korea’s, it is more likely that foreign capital here would leave Korea, because money tends to flood into areas with higher stability and higher interest rates. This would weaken investment in Korea, which would reduce the number of jobs, and in turn it would lead to lower economic growth. Overall, it would dampen the expectations of economic recovery.

However, as market participants had already predicted such a move of the U.S. to raise interest rates, some argue it would not affect the domestic economy of Korea that much. Shin Min-young, a researcher at the LG Economic Research Institute predicted, “Capital movement is related to foreign exchange rates as well as interest rates,” adding, “True, higher interest rates make the U.S. dollar strong, but over the long haul, the dollar is highly likely to weaken, and capital outflow from Korea would not be so serious.”

Weak Influence on the Market –

Foreign exchange rates and stock prices showed lukewarm response to the news of the U.S. raising interest rates. The Korean won against the U.S. dollar depreciated by 2.5 won (appreciation of the Korean won) to 999.8 won, reaching below the 1,000 won level in three days. An official at the foreign exchange market explained, “Rather than the higher U.S. interest rates, concerns over China’s possibly appreciating its yuan plummeted the yen-dollar rate and the won-dollar rate. The Korean Composite Stock Price Index rose by 15.53 points (1.70 percent) from the previous day to 929.35, and the Kosdaq index increased by 6.11 points (1.44 percent) to close at 429.41.

Ji-Wan Cha Sun-Woo Kim cha@donga.com sublime@donga.com