Central bank moving toward rate hike

By Kim Jae-kyoung

Staff Reporter

The central bank is showing signs of tipping the balance of its monetary policy in favor of rate hikes, joining a global wave of unwinding economic stimulus measures taken to minimize the economic downturn in the wake of the global financial crisis.

Market analysts expect that a rate increase will not come in the coming months but Bank of Korea (BOK) Governor Kim Choong-soo will deliver a hawkish commentary following another rate freeze at the upcoming rate-setting meeting slated for May 12.

In its semi-annual financial stability report, the Bank of Korea (BOK) stressed the need to carry out its monetary policy in a preemptive manner, saying that the effect of rate increases on the economy will be limited. The BOK froze the key rate for the 14th straight month in April.

It pointed out that there is ample liquidity in the market due to a protracted low interest rate policy, and this has caused undesirable side effects, such as a rapid rise in money in circulation and a delay in corporate restructuring.

``Although there are lingering uncertainties surrounding the Korean economy, some data suggests that the economy is getting back to a full track recovery,'' a ranking BOK official said, asking not to be named. ``We are keeping a close eye on the possible side effects of the protracted low rate policy.''

The warning is taken as a BOK's attempt to ignite a debate over rate hikes to create an atmosphere for stepping to halt the credit-easing campaign. The delicate change in its economic view came after a number of warnings about the protracted low rate policy were issued.

At a meeting with reporters Friday, Korea Institute of Finance (KIF) President Kim Tae-joon said that the current key interest rate level is abnormally low, calling for the central bank to raise interest rates.

He pointed out that there are symptoms of the protracted low rate policy as a result of a surge in liquid assets in the market as well as a delay in corporate restructuring.

The IMF recently said that with the recovery now well under way, it is appropriate to think about the timing and pace of withdrawing macroeconomic stimulus.

The rationale behind such warnings is that the Korean economy is now getting back on the full recovery cycle. The economy grew at the fastest pace in more than seven years in the first quarter of the year, with gross domestic product (GDP) expanding 7.8 percent from a year ago.

Industrial output grew by 22.1 percent in March from a year ago, continuing positive growth since last July. Business confidence rose to a more than seven-year high for May, with the index of manufacturers' expectations climbing to 107 for May, the highest level since the fourth quarter of 2002.

Debate Over Rate Hikes

Many analysts said that the central bank should start lifting the key rate as soon as possible to head off a possible real estate bubble and curb inflation expectations down the road.

``There are long-term risks to the economy from delaying rate increases. Rising inflation and misallocation of assets are obvious risks. Another risk is that a protracted low-rate policy can cause future monetary policy to become less effective,'' Morgan Stanley economist Sharon Lam said.

``If the rate level is not normalized now, there will be limited room to cut rates when the economy slows again. This runs the risk of a near zero interest rate in the worst case scenario, which we think the central bank should avoid,'' she added.

Independent economist Andy Xie also said that emerging economies, including Korea, used low interest rates to juice up property to offset the export downturn during the global crisis.

``It's making a bubble to offset the impact of another bubble bursting. It doesn't feel painful now, but the side effects will come. Korea should raise the interest rate as soon as possible to allow property to normalize. Delaying creates more pain later,'' he added.

On the other hand, Strategy and Finance Minister Yoon Jung-hyun said that it is too early to implement exit plans.

``Korea is seeing economic indices improving, and it is recovering at a quicker pace than other nations, but we can't say it is on a full recovery track as the job market is still faltering and the private sector hasn't recovered on its own yet,'' Yoon said during his recent visit to the U.S.

Global Exit Move

A series of moves by central banks abroad to normalize monetary policies are expected to give more leeway for the BOK to advance the timing of its exit strategy.

On April 28, Brazil's Central Bank raised its key rate or Selic rate to 9.5 percent from a historic low of 8.75 percent where it had stood since July 2009, citing concerns that Latin America's largest economy is at risk of expanding too quickly.

Last week, the Bank of Canada hinted that it will raise interest rates soon, possibly as early as June 1. The Reserve Bank of Australia is also expected to lift the benchmark interest rate by another 25 basis points in May to 4.5 percent from 4.25 percent the previous month. The bank has raised borrowing costs five times during its last six meetings.