BOK's rate hike clock speeds up amid oil-fueled inflation pressure

Bank of Korea (BOK) Gov. Shin Hyun-song speaks during his inauguration ceremony at the BOK headquarters in Seoul, April 21. Joint Press Corps

The Bank of Korea (BOK) faces mounting pressure for further monetary tightening as a spike in global oil prices triggered by conflict in the Middle East fuels inflation and pushes up the won-dollar exchange rate. Market analysts increasingly expect the central bank to resume rate hikes in the second half of the year.

BOK Gov. Shin Hyun-song is set to chair a Monetary Policy Board meeting on Thursday, his first since taking office in April, with markets closely watching for signals on his policy direction.

The central bank has kept its benchmark interest rate unchanged for seven consecutive meetings after cutting it to 2.50 percent in May last year.

The bank is widely expected to keep rates unchanged at the upcoming meeting, while signaling the possibility of future rate hikes.

"In our base case, we expect BOK to deliver an evidently hawkish hold decision at 2.50 percent policy rate at the meeting," said Kim Jin-wook, chief economist at Citibank Korea.

Surging oil prices and the won's sharp decline against the dollar are adding to inflation concerns and reinforcing expectations of monetary tightening. The won-dollar exchange rate has hovered around the 1,500 level, a psychologically significant threshold in local currency markets.

Inflationary pressure is also mounting due to the prolonged Middle East crisis.

Korea's producer price index, a key indicator of future inflation, rose 2.5 percent in April from a month earlier, according to BOK data. It marked the steepest monthly rise since February 1998, when producer prices jumped 2.5 percent during the Asian financial crisis.

Economists say consumer inflation for May could approach 3 percent as the impact of higher oil prices and the weakening won increasingly affect domestic prices.

While slowing economic growth had previously constrained the BOK's room for tightening, strong semiconductor exports and stronger-than-expected growth have shifted the focus toward inflation control rather than growth support.

Driven by the global artificial intelligence-led semiconductor boom, Korea's real gross domestic product grew 1.7 percent in the January-March period from the previous quarter, marking the strongest quarterly expansion since the third quarter of 2020.

Container boxes are stacked at a port in Pyeongtaek, Gyeonggi Province, May 8. Yonhap

Kim expects the central bank to raise rates by 0.25 percentage point in both July and October this year, bringing the benchmark rate to 3 percent by year-end, followed by additional hikes in January and April next year that would lift the terminal rate to 3.5 percent.

Cho Yong-gu, an analyst at Shinyoung Securities, said the BOK could raise rates by 0.25 percentage point each in the third and fourth quarters of this year and the first quarter of next year, bringing the benchmark rate to 3.25 percent before shifting to a pause.

"The key question is whether global oil prices will remain above $100 a barrel through the end of June," Cho said. "If elevated oil prices persist through July and August, expectations of rate hikes could intensify."

BOK officials have also signaled the possibility of tighter monetary policy.

Ryoo Sang-dai, the BOK's senior deputy governor, recently said it was time to begin considering rate hikes, citing stronger-than-expected first-quarter growth.

"When we kept the policy rate unchanged in April, we expected the (Iran) war could lower our growth outlook and raise our inflation forecast," Ryoo said during a press conference on May 4.

"Since then, economic growth has remained above 2 percent, while inflation may exceed 2.2 percent. Given this, it is time to stop discussing rate cuts and start considering rate hikes."

Kim Jin-il, who joined the Monetary Policy Board on May 15, also hinted at tightening, saying, "Slightly higher interest rates would help reduce the risk of financial instability."