The Bank of Korea undertook another 50-basis-point hike on Wednesday. It was the fifth consecutive interest rate hike and the second big step three months after the central bank’s first “big step” increase. Such undertaking aimed to stabilize skyrocketing dollar value against the Korean won and control the high inflation rate. However, the BOK originally planned to take a gradual interest rate hike due to concerns over the potential economic recession and mounting household debt. It only took the second big step pushed by a worsening global economy.
Now the policy rate of Korea is 3 percent for the first time since October 2012. The hike was already forecasted with the inflation rate going five percent range, much higher than the targeted rate of two percent the central bank had set. The strong dollar is likely to bring a severe issue as Ben Bernanke, this year’s Nobel laureate in economics and former chairperson of the Federal Reserve of the U.S., warned that “Emerging markets including those in Asia are facing a very strong dollar and thus risk of capital flight.” South Korea is also experiencing a higher burden from oil and commodities imports due to the strong dollar, leading to a trade deficit. An interest rate hike was necessary to respond to the situation.
The problem, however, lies in the interest rate gap with the U.S. despite the BOK beginning the hike in August 2021. The U.S.’s base rate is currently at 3.0 – 3.25 percent and is highly likely to go up to 4.5 percent by the end of the year, with two more hikes planned. Even if the BOK takes another major big step in November this year, the last chance to raise the rate, it is still unlikely to catch up with the U.S. rate.
This results from a misjudgment made by BOK Governor Lee Chang-yong and the members of the Monetary Policy Board, who thought it was unlikely that the U.S. would take a significant interest rate hike of 75 basis points three times in a row. Even when Fed Chairman Jerome Powel commented that it would keep raising the rate until the job is done,” Governor Lee responded. “Korea will not expedite the speed of interest hike.” Yet, this time, he had no option but to go back on his word of a “gradual 25 basis-point hike” but chose to take the big step.
The recurrence of such misjudgment about surrounding situations by the BOK will weaken the trust of the domestic and the global market in the bank. The market may end up not trusting its announcement of “no shortage in foreign exchange reserve” or “can maintain the surplus in yearly current balance” Thus, the BOK should not hastily judge the situations regarding the base rate and should be more agile and flexible in responding the fluctuating inflation and exchange rate indexes.