More increases likely in 3rd quarter

By Kim Jae-kyoung

Staff reporter

Following the surprise rate hike by the Bank of Korea (BOK) Friday, market participants are trying to figure out whether it is the beginning of a series or just a one-off action.

Although economists are widely split over the future course of monetary policy, more are betting on additional rate increases in the coming months, citing a strong economic recovery and rising inflationary pressure.

Roubini Global Economics (RGE), a U.S. financial analysis firm headed by New York University economics professor Nouriel Roubini, better known as "Dr. Doom," forecast additional rate hikes in the third quarter, saying that the BOK is decoupling from the Fed.

"Given revival of capital inflows in June, rising inflationary pressures and risks from negative real interest rates, South Korea will hike rates by another 50 basis points in the third quarter," RGE said in an email interview with The Korea Times.

"This will be followed by a 25 basis point hike in the fourth quarter, unless domestic and global growth slow more than expected or there's a repeat of a May-like sell-off. Rates will go up by at least 75 basis points in 2011," it added.

"Together with Malaysia, Taiwan and India's recent rate hikes, it shows that though Asia's growth is still dependent on U.S. and EU demand, differences in economic recoveries and inflation dynamics in Asia and G3 economies imply that EM Asian central banks are decoupling from the Fed."

The rationale behind growing expectation for more rate increases is that the current level of the key rate is too low, compared to the Korean economy's growth potential. The policy rate now remains well below the pre-crisis level of 5.25 percent. The rate is also way below GDP growth of at least 5 percent forecast for this year.

In a research note, Morgan Stanley senior economist Sharon Lam also forecast a total hike of 50 basis points for this year, which implies one more rate hike of 25 basis points to come.

"I do not anticipate another hike in August, but one may be possible in September if the external environment does not deteriorate significantly from here. I also do not rule out the possibility of one more hike in the fourth quarter. I look for 125 basis points hike in 2011," she said.

Following the BOK's preemptive action, ING Group revised its key rate outlook. It now forecast one more rate hike this year, followed by a 100-basis points increase in 2011.