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Bank of Korea needs a strong signal before inflation is under control

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(Bloomberg) — The Bank of Korea needs to see strong signs that inflation is under control before plotting a turnaround for policy tightening, Gov. Ri Chang-yong said Friday.

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The central bank was nearing the end of its tightening cycle when it raised its key rate by 25 basis points to 3.25% on Thursday. The board of the BOK has different opinions on the final interest rate: three are in favor of 3.5%, one thinks enough has been done, while two want the door open to go above 3.5%.

“In the first half of next year at least, we’ll be thinking about when to stop and how to handle this inflation,” Ri said in an interview with Bloomberg TV’s Kathleen Hayes. “Once we see strong signs that inflation is under control, we will have to think about the next trade-off.”

Citi Group Inc. and Nomura Holdings Inc. forecast that the BOK will start cutting rates as early as mid-2023, expecting the Korean economy to need policy support.

Ri said several factors will help determine policy direction, including the Federal Reserve’s decision in December, global oil prices, China’s COVID policies and the credit market situation in Korea.

“Taking all these factors into account, we decided to keep our flexibility and think about our next step, maybe in January,” said Ri. “It will be very difficult to judge where and when we will stop, but our board members think we might be able to go to about 3.5 percent.”

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The governor said he wouldn’t be surprised if some board members changed their mind about the final course. He declined to give his own forecast, saying he would reveal it if the board was evenly split.

He said it is “premature” to discuss any interest rate cuts and that the BoK needs stronger evidence of slowing inflation to its medium-term target of 2% before the board can discuss the possibility of policy easing. . The latest forecast from the BOK, published on Thursday, shows that inflation will be above 2% through 2024.

The bank has increased the total by 2.75 percentage points since August 2021, including two half-point moves. The tightening helped position Korea ahead of most countries in the battle against an asset bubble and inflationary pressures.

However, the rapid general tightening in recent months has increased credit risks posed by the default of a local government-backed developer.

“I think there’s extreme sensitivity,” the governor said of credit risk. Coupled with the UK’s now-withdrawn stimulus, the Korean case is teaching the world that “one small mistake can put an entire economy at risk”.

Overall, Korea’s financial markets are in good shape despite a credit crunch in the real estate market, which resulted from a failure in the local province, he said. Ri probably underestimated the need to provide liquidity support, as seen at the start of the pandemic.

“You can’t give this heavy drug until you’ve tried other remedies,” he said.

In a sign of the credit crunch, the Korean corporate bond market contracted the most ever last month. Meanwhile, credit yields have risen.

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“I wouldn’t be surprised if they don’t fall because we’re still raising rates,” Rea said.

Rapidly growing exports are another concern on Ri’s mind. Korea reported a drop in overseas shipments for the first time in two years in October, with chip sales falling the most since late 2019.

The BOK on Thursday predicted the economy would grow at 1.7% next year, much slower than an earlier forecast, while inflation was pegged at 3.6%.

Ri said inflation would remain high early next year, prompting the bank to “focus more on how to stabilize it” as growth slowed due to a “more severe recession” in Europe and the US. Is. He also highlighted Korea’s heavy reliance on chip prices.

Rhee took office in April as head of the Asia-Pacific division of the International Monetary Fund, the institution that saved Korea during Asia’s financial crisis a quarter of a century ago.

While today’s Korea bears little resemblance to the economy, the credit crunch exposed its weaknesses as a country closely aligned with the global economy and the Fed’s policies.

Ri said earlier this year that the BOK may have gained independence from the Korean government, but not from the Fed. The recent hike reflected the urgency to keep pace with the Fed to mitigate the risk of capital outflows that could nullify the win.

“What I mean is that as a small open economy, the foreign exchange sector is one of the important factors in determining monetary policy,” he said. “We don’t automatically follow US interest rates, but we are very aware of its impact on our exchange rate.”

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The Fed’s rate hike hit the won, the worst performing currency in Asia this year after the yen. This has made imports from Korea more expensive and increased the financial burden on the country’s debt-ridden households.

“Korea’s debt ratio, especially domestic debt, is relatively high,” he said, calling it a medium-term challenge. “You can’t make a profit in too short a time. It will have too many negative side effects.”

– With assistance from Jaehyun Eom and Kyungji Cho.

(Update with rate cut speculation, charts, further comments.)

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