By Kim Tong-hyung
Korea’s central bank kept its key interest rate on hold at 2.75 percent Friday. The decision surprised many observers as the country has been struggling to combat soaring inflation.
Policymakers have been under pressure to consider raising borrowing costs to rein back inflation. But the Bank of Korea (BOK) can’t be bold on clamping down on money supplies when higher prices appear to be coupled with slowing growth.
The bank’s monetary policy committee had lifted the benchmark policy rate by a quarter of a percentage point in January, following a previous hike in November, as it sought to tame rising prices. The latest decision was widely unexpected and the level of division within the committee will not be confirmed until the minutes of the meeting are released six weeks later.
Speaking to journalists after the meeting, BOK Governor Kim Choong-soo admitted that the central bank faces a difficult choice between keeping rates low to help the economic recovery or raise them to suppress prices.
The decision to leave the rate unchanged indicates that the bank prefers to have more time to monitor how the effect of the January rate hike takes hold, as well as the impact of the package of anti-inflation measures introduced by economy-related ministries. However, this also elevates the chances of a March rate rise, analysts say.
Kim said he expects the Korean economy will maintain what he called an ``upward trend’’ trend. He identified external factors such as rising oil prices, influenced by the political unrest in Egypt, and the ongoing financial uncertainty in Europe as risks.
``It was not a unanimous decision,’’ said Kim, stressing that the bank will carefully control its pace for regaining a normalized level in interest rates of above four percent.
``With the economy regaining its energy and the rise in internal oil prices, we expect consumer prices to continue to rise in the levels of around 4 percent in the immediate future … Although we believe that the impact of the supply side pressure that has been driving inflation will weaken in the coming months, especially with the government’s set of anti-inflation measures, inflation expectations are likely to persist and this warrants close monitoring.’’
Concerns over inflation have been growing, as the rise in consumer prices continues to exceed the 4 percent ceiling set by the BOK. This poses a considerable challenge to the country’s growth-first monetary policy.
Consumer prices climbed 4.1 percent year-on-year in January, matching their biggest increase since 2008, driven by the rising price of essentials such as food and fuel. And producer prices increased 6.2 percent in January from a year earlier, the largest gain since November 2008, and up 1.6 percent from December. This represented the fastest pace in more than two years, according to the BOK’s latest figures announced on Friday.
It’s tricky to touch the rates when data shows most components of the economy shrinking, stoking fears of stagflation, a depressing combination of recession and inflation.
The country’s inflation-adjusted gross domestic product (GDP) rose 0.5 percent in the three months that ended in December, down from the 0.7 percent growth showed in the previous quarter. There had been concerns that an imminent rate rise would stifle recovery.
There is also an argument that higher rates wouldn’t do much in the fight against inflation. Prices are driven mainly by increasing commodity and energy costs, which are obviously beyond the BOK’s control.
Oh Suk-tae, chief economist at Standard Chartered First Bank, said that the BOK appears to have concluded it couldn’t be too fast or slow and established a pattern of raising rates every other month. He predicted the base rate to end the year at around 3.5 percent.
``It seems that the bank has decided that a hike every two months is the appropriate speed for now. A back-to-back raise would have been a burden the central bank wasn’t ready to take,’’ Oh said.
``It’s widely expected that the inflationary pressure will ease in the second half of the year, perhaps reduced to a level of around 2 percent, and the BOK has to be wondering what it could do then.’’
Putting growth before inflation, policymakers have displayed reluctance to elevate borrowing costs dramatically and instead resorted to price controls, such as stemming the increases in public utility bills, university fees and other consumer items.
Critics argue that the inflationary pressure has become too great to disregard. They say the country has enough room to raise borrowing costs without hurting growth due to robust exports and industrial production. Last month, Korea set a new monthly high of $45 billion in exports, while its industrial output increased for a second straight month in December.
The BOK’s decision to maintain its base rate comes at a time when central banks around the world find themselves increasingly concerned about price stability. China recently upped its interest rates for the third time since the autumn and other Asian economies such as Taiwan and Thailand are expected to follow suit.