Rising inflation presses BOK to hike rates

By Kang Seung-woo

The Bank of Korea (BOK) is expected to raise its key interest rate this month, with a faster-than-expected increase in consumer prices tipping the balance of monetary policy in favor of further credit tightening.

In addition, given that there are a lot of liquid assets in the market and the real interest rate remains in negative territory, the central bank will be expected to be under growing pressure to fixing it up in three months.

The BOK has frozen its key interest rate at 2.25 percent since it raised it by 0.25 percent from a record low of 2 percent in July and its monetary policy committee will negotiate the October’s rate next week.

According to Statistics Korea on Friday, the consumer price index hit a 17-month high of 3.6 percent last month from a year earlier, which was higher than the government’s early prediction of a low 3 percent.

It was the first time for the index to surpass the 3 percent mark since January, when it tallied 3.1 percent. Worse, the index climbed 1.1 percent from August to post the biggest monthly gain since March 2004, which saw it go up 1.2 percent from the previous month.

Market analysts said that to curb the increasing inflation pressure, the BOK is expected to raise its policy rate by 25 basis points to 2.50 percent in the coming months.

“(Inflation) data increase our confidence in our forecast of a 25 basis point rate hike at the Oct 14 policy meeting. The BOK began normalizing in July,” ING Group senior Asia economist Tim Condon said in his research note.

“We believe “normal” is 3.50 percent and that the BOK will get there in the second half of 2011,” he added.

The BOK said that soaring prices of fresh products, which rose 45.5 percent year-on-year, affected the upward trend. In fact, the inflation rate of fresh-produce price has already exceeded that of consumer prices since March last year. In its effort to mitigate the soaring vegetable prices, the government will temporarily remove its tariffs on cabbage and radish imports.

“Prices of agriculture, fishery and livestock products will settle down a little bit, but the probable inflation pressure from other products will catapult the rate over 4 percent. BOK needs to take a preemptive action to ease the pressure and it is likely to hike the rate as part of warning to the market,” another Seoul-based analyst said.

Along with growing inflationary pressure, below-zero real interest rate and the ample liquidity in the market caused by the government’s stimulus measures are also affecting a possible rate hike.

Recently, local banks’ deposit rates have slid to a 3 percent level due to the decline of bond rates.

Reflecting inflation and taxes, the interest rates have actually dipped into negative territory.

However, there is some opposition to the hike amid concerns that the economic recovery is faltering, as several indicators showed poor performances.

Last month’s leading composite index and the cyclical component of the composite coincident index suffered a joint decline, while the industrial output slowed down.

The leading index is used to predict the economic performance eight to 15 months ahead and the cyclical index reflects current economic situations.

Falling exchange rates are another issue because a rate hike can cause them to go lower.