Looming Rate Hike
Fundamental Measures Required to Reduce Excess Liquidity
Market players are paying keen attention to the possibility of the central bank’s raising its target interest rate as early as next month. Financial experts seem to believe that a rate hike will be inevitable considering the volatile market situation. An upward adjustment of the call rate has gained momentum since Lee Seong-tae, governor of the Bank of Korea (BOK), made remarks about excess liquidity early this month. The call rate refers to interest charged on overnight loans between banks.
Given the overheated property market and a sudden rally of the stock market, the BOK should have increased the call rate in a pre-emptive manner. That is, the BOK has failed to properly wield its monetary policy to bring inflationary pressure under control. The prime role of the central bank is to maintain price stability. It ought to hike or cut interest rates well ahead of economic overheating or a slump because the intended consequences usually occur about six months later. However, the BOK has maintained a low interest policy over the past several years, overlooking the skyrocketing prices of homes and apartments.
No doubt that the government and the central bank have collaborated in keeping interest rates low in efforts to stimulate the economy. However, this policy has generated an excess money supply that is blamed for stoking property speculation. Now that the property market shows signs of losing steam, superfluous liquidity is rapidly flowing into the stock market and it’s time to worry about stock speculation.
Monetary policymakers had better realize that the volatile market situation cannot be changed without tightening money supply by raising interest rates. Or they may think that it’s too late to take action against overheated market sentiment because the speculative mood has already become so strong. They can also say that belated action to increase the rates would only pour cold water on the economy that is on a stable recovery path. But what if the stock market heads for a crash and the bubble bursts? We hope that the possible crash won’t develop into another financial meltdown reminiscent of the 1997-98 Asian crisis.
It is obvious that excess liquidity is the main culprit of property speculation and the volatile stock market. The benchmark stock index KOSPI has suddenly soared to the 1,800 level. There is a debate on whether the market is overheated or not. But the problem is the rapid pace of the rally. Policymakers will have to take more fundamental measures to reduce excessive money supply to prevent a market crash.
Household debt totaled 671 trillion won ($721 billion) last year, a significant rise from 496 trillion won ($533 billion) in 2002. People have borrowed huge sums from banks to buy up houses and stocks. Each household is indebted 36.4 million won ($39,182) on average. We have to think about what would happen if the bubble bursts.