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Record large gap in interest rates between S.. Korea and US

Record large gap in interest rates between S.. Korea and US

Posted July. 28, 2023 08:11,   

Updated July. 28, 2023 08:11


The U.S. Federal Reserve raised its key interest rates by 0.25 percent points on Thursday, making it the eleventh hike following the recent one announced in March. It resumed its austerity measures just less than a month after freezing its benchmark rate in June. The decision was made to seemingly represent the Fed’s confidence about a soft landing for the U.S. economy and help achieve the goal of getting inflation down to 2 percent. The result was the highest yearly interest rate of 5.25 to 5.5 percent in 22 years. Given that South Korea’s yearly interest rate of 3.5 percent has remained unchanged since it rose in January, the gap in interest rates between the two countries grew up to an unprecedented level of two percent points.

Even though it came as no surprise to the South Korean government and the Bank of Korea assessing it as “results within expectations,” it is obvious that the country with a high reliance on overseas markets will be faced with greater burdens. In fact, it is never free from financial concerns that foreign investors will flee the local market in pursuit of higher interest rates, and the South Korean won will depreciate. It is at least comforting that the won-dollar exchange rate has hovered around the 1,270 range while stock and bond investment funds have recorded a net inflow for five consecutive months. Nevertheless, it is not the time to feel relieved.

Although many experts project that this interest hike will be in effect the last one for some time, there is still a likelihood of a greater gap in interest rates between South Korea and the United States as Federal Reserve Chief Jerome Powell left open the possibility of either increasing or freezing the interest rates this September. As he clarified that no interest rate fall is planned for this year, the highest interest rate gap will remain the norm over a considerable period.

The issue is that South Korea is not as resilient against the interest rate gap as it was at a time of a reversed interest rate gap because it struggles with the underperforming real economy teased by disappointing exports and trade deficits. What’s worse, the domestic economy barely avoided negative growth rates over the first two quarters of this year, while yearly growth rates are expected to decline. These challenges make it hard for the central bank to choose a hike as a solution. Another risk factor is household debts reaching an irreversible level. With some signs of changes in loan interest rates recently shown, household loans taken out from banks rose by as much as six trillion won last month alone.

To make things worse, the Fed’s return to interest rate hikes could bring back financial insecurities to U.S. local banks and exacerbate the slowing commercial real estate market. If that is the case, the South Korean financial field will not be safe from shock. There are already some signs of imminent risks. Specifically, South Korean stock firms have invested 15.5 trillion won in overseas properties; foreign real estate funds that mature within two years are estimated at around 30 trillion won. Any external shock, once it arrives, can deal a critical blow to the local financial market and cause sudden, massive capital outflows.

The government and currency authorities need to preemptively look at risk factors arising at home and abroad to respond to volatility in financial markets. Like the currency swap deal signed with Japan, the country should expand its currency swap with other global central banks to secure the safety valve of the dollar. It must be a mistake to stay laid back assuming that the gap in interest rates compared to the United States appears to cause little instability for the moment.