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By Jeon Yong-bae
In the Jackson Hole meeting in August, Federal Reserve Chair Jerome Powell compared the current management of monetary policy to "navigating by the stars under cloudy skies." He firmly stated that the Fed is not contemplating an increase in its 2 percent inflation target and that there will be no pivot in its interest rate policy (interest rate cut) in the near future.
He also noted Fed policy is likely to remain highly dependent on data such as inflation and the unemployment rate.
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This has placed the Fed in a dilemma because it needs some additional softening in the U.S. labor market and a downshift in wage inflation to be assured that price inflation is on a trajectory toward the 2 percent longer-run target. Market participants predict one more interest rate hike this fall followed by an extended pause.
In the eurozone, the possibility of further interest rate hikes has increased due to persistently high inflation. The August CPI was 5.3 percent, far exceeding the target of 2 percent, and it is expected to remain above 3 percent next year.
Despite concerns about an economic slowdown, the European Central Bank (ECB) has raised its benchmark interest rate for the ninth consecutive time. It is expected to focus on price stability until the end of the year. There is also a need to defend the value of the euro, which is depreciating against the dollar, through interest rate hikes.
Japan is also hinting at changes in its monetary policy by next year. Japan's CPI has been maintaining a 3 percent range for 12 consecutive months since August last year, surpassing the Bank of Japan's (BOJ) target of 2 percent. With the weakening of the yen in the second half of this year, along with significant increases in energy and raw material import costs, inflationary pressures will intensify further.
Therefore, the BOJ is expected to end its negative interest rate policy. The yen, at 147 yen against the dollar, is currently at its lowest level in the past 10 months. While the weakening yen benefits Japanese exports, it has a negative impact on inflation for Japan, which relies heavily on imports such as oil and raw materials.
Central bank in dilemma
The Bank of Korea (BOK) faces a different situation. While the United States has raised its interest rate several times, the BOK has been cautious about raising its rate, taking into consideration domestic economic conditions and record-high levels of household debt.
Currently, the interest rate gap of 2 percentage points between the U.S. (5.5 percent) and Korea (3.5 percent) is at its highest level ever. Foreign capital invested in Korean stocks and bonds may stay in the country as long as it expects steady growth or recovery of the economy despite its low interest rates.
However, if there are signs of an economic downturn or financial instability, it could quickly withdraw like a tide. In such a situation, the value of the Korean won could decline, leading to a sharp increase in the exchange rate and causing both domestic and external difficulties.
The BOK needs a proactive response by raising interest rates minimally to protect the Korean won and ensure stability in the domestic capital market. The risk of a domestic economic slowdown is always present. With sluggish exports, which are the driving force of economic growth, and limited consumer spending power due to high household debt, domestic demand is not picking up easily. Policymakers may argue they should revive the economy even if it means lowering interest rates.
However, from a macro perspective, it is also very important to evaluate matters relative to the circumstances in other countries due to Korea's high dependence on external factors.
The writer is a senior consultant and auditor of Franklin Templeton Investments Korea, where he previously worked as CEO, and is a professor of the University of Maryland Global Campus' MBA program.
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