Central bank freezes rate

Kim Choong-soo, governor of the Bank of Korea, bangs the gavel during a meeting to decide a benchmark call rate at its headquarters in Seoul, Thursday. South Korea’s central bank has frozen its key interest rate one month after raising it to fight persistent inflation. / AP-Yonhap

By Kim Tong-hyung

The Bank of Korea (BOK) kept the country’s policy rate unchanged at 3.25 percent despite high inflation, as the heightened uncertainty surrounding European financial troubles dissuaded rate setters from hiking.

The decision by the central bank’s monetary policy committee Thursday had been widely expected and BOK Governor Kim Choong-soo warned against raising interest rates too quickly, insisting that the country has already suffered the worst of the inflationary pressures.

Inflation, which has stubbornly remained above 4 percent, has exceeded expectations every month this year through June, forcing the government to downgrade its growth forecasts in a pre-election year.

But despite concerns about the damage in spending power and savings undermining Korea’s fragile recovery, the bank’s rate setters have been reluctant to clamp down on money supply as they question the country’s ability to cope with higher borrowing costs.

The decision to hold rates was unanimous, Kim said. The bank has adjusted its annual forecasts for gross domestic product (GDP) growth and consumer price inflation, which will be announced on Friday, although the changes are expected to be cosmetic.

BOK surprised analysts by lifting the benchmark rate by a quarter of a percentage point in June.

However, the bank has hiked the rate by just 1.25 points since July last year as it stressed “baby steps” in returning the number to a normalized level of 4 to 5 percent as it was before the start of the recession.

“Although the world economy continues to be on a recovery track, the debt crisis in Europe and possible volatility in neighboring economies pose downward risks. We expect the Korean economy will continue its upward movement amid persisting external threats,” said Kim.

“We believe that high inflation will continue for some time, due to demand pressures and inflation expectations. Core inflation has been rising and that will likely continue due to the increase in processed foods and services bills.

“Considering all the domestic and external factors affecting our economy, we agreed it was best to keep the benchmark rate as it is and keep a close eye on what happens from now. The role of monetary policy will be to continue supporting the economy’s recovery, but also balance this with the commitment toward price stability.”

BOK’s decision to hold interest rates comes amid increasing fears that the European travails are proving to be bigger than just a Greek tragedy as more eurozone nations face prospects of insolvency.

There are also worries about a subduing U.S. economy, which had Federal Reserve Chairman Ben Bernanke declaring recently that new stimulus efforts are on deck.

The Korean economy faces serious domestic challenges as well. Consumer prices jumped 4.4 percent on an annualized basis in June.

The so-called “core” inflation, which excludes volatile elements such as food and energy, was measured at 3.7 percent, the highest level in 25 months.

The slew of bad data forced the government to reduce its annual growth forecast for the country from 5 to 4.5 percent and lifted its inflation predictions from the 3 percent range to 4 percent.

BOK predicts the price pressures will weaken later in the year and predicts that declining producer prices will eventually show in the consumer price index (CPI), the country’s key measure of inflation.

But some observers fear that inflation could hit a new peak driven by substantial rises in fuel and utility costs that are beginning to take hold.

Heavy rain in recent weeks, which is hurting crop yields across the country, appears to be pushing fresh food prices up again, and it doesn’t help that this is one of the years when the Chuseok holidays, an annual inflation feeder, fall in early September.

“Although the overwhelming view is that fuel prices aren’t going to go up much further, it’s also hard to say that they will stabilize at a level that is significantly lower than now. We need to closely monitor how the changes in fuel costs will impact overall inflation,” Kim said.

It’s hard to deny that maintaining growth had assumed greater importance than meeting the inflation target to policymakers in past months, which had BOK suppressing its trigger finger despite the acute squeeze in the living standards of the middle class and struggling families.

However, the bank could be playing with fire when considering that the country’s historically high level of consumer debt, which at 1 quadrillion won (about $948 billion) matches an entire year’s GDP, is becoming a ticking time bomb for the economy.

Kim said that concerns over the effect of future interest rate rises among indebted households influenced the bank’s decision to keep to the current rate. But critics argue that cheap loans, aside from providing a little pain relief in interest payments, will aggravate the country’s debt problem by extending expectations for low borrowing costs.

The borrowing binge of Korean households was driven by speculative demand for property in previous years. But the housing sector has been in freefall since the recent recession, leaving scores of homeowners trapped with negative equity.

“Property-backed loans continue to increase and we are noticing that more and more people are using these loans to finance other things than housing. But with the government implementing plans to reduce household debt, we believe that the situation will improve,” Kim said

“This is not a problem that was created overnight so it can’t be cured overnight either.”

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