By Yoon Ja-young
Another U.S. Federal Reserve rate hike this week will add upward pressure on money market rates here, analysts said Sunday, eventually increasing the debt repayment burden for households sitting on a record in home-backed loans.
The U.S. Fed is expected to raise its key rate by 0.25 percentage points to between 1 and 1.25 percent at the Federal Open Market Committee meeting this week, on positive economic indices and financial markets.
The United States’ unemployment rate fell to the lowest level in 16 years while its stock indices have been rising to record highs.
This means any rise will place the Fed’s rate at the same level as that of Korea, which has been maintained at 1.25 percent since June last year. If the United States raises the key rate again in the latter half of the year, it will become higher than that of Korea.
The unusual reverse in key rates will leave little room for the Bank of Korea (BOK) to maneuver, making it almost impossible to conduct a rate cut.
Even if the BOK maintains its key rate, the market rate is likely to rise on upward pressure coming from external factors.
“The lending rates for households and businesses are also likely to rise following any increase in market rates,” said Lee Chang-sun, a senior researcher at the LG Economic Research Institute.
Lee said that because the rise stems from external factors not accompanied by economic recovery or increased income here, it might lead to a contraction in consumption and an economic slowdown on top of the increasing vulnerability of households.
“There should be policies to restrain a steep rise in market rates,” he said.
Analysts express concerns that the rising interest rates will pose a threat to household debt which is nearing 1,400 trillion won ($1,240 billion).
According to the BOK, only 25.4 percent of household loans are offered at interest rates lower than 3 percent, which is the lowest ratio since 2015 February. Meanwhile, the ratio of loans subject to an interest rate of between 3 and 5 percent has risen to 53.5 percent.
“Though Korea’s key rate has been frozen, the lending rate has been rising following hikes in the United States. This can lead to a contraction of consumption as households cut spending due to the burden of repaying loans,” said Shin Yoo-ran, a researcher at the Hyundai Research Institute.
“It increases the likelihood of them selling off their assets, which will pose risks to the market as well.”
In theory, a higher U.S. rate than that of Korea could lead to a capital exodus from Korea. As the U.S. market is more stable, the interest rate is supposed to be lower there than in Korea which has geopolitical risks. A lower interest rate in Korea can thus lead to capital flight.
However, analysts say that an exodus is unlikely.
“On top of the interest rate gap, the outlook on foreign exchange rates determines the flow of capital. When considering Korea’s sovereign credit rating and foreign exchange soundness, the market won’t expect the Korean won to weaken seriously enough to trigger a massive outflow of foreign currencies,” said Lee at the LG Economic Research Institute.