Early rate hike ahead of Fed's move minimized economic costs: BOK chief

Bank of Korea (BOK) Gov. Shin Hyun-song said Monday that the central bank's August rate hike ahead of the U.S. Federal Reserve's September move gave Korea more time to respond and helped minimize the economic costs of monetary tightening.

"We signaled a shift toward higher interest rates earlier than many other major economies. By raising rates in August, ahead of the Fed's September hike, we bought ourselves time," Shin said during a parliamentary audit of the central bank.

"Taking action early carries far lower economic costs than having to raise rates defensively in response to market pressure," he added.

Shin said the preemptive move also helped guide market expectations, noting that the prospect of BOK's rate increases was reflected in bond yields and other market prices before the hikes actually took effect.

The BOK raised its policy rate by 0.25 percentage point in both July and August, bringing it to 3 percent. The Fed raised its benchmark rate by 0.25 percentage point in September, its first increase since July 2023, to a range of 3.75 percent to 4 percent.

During the audit, Shin left the door open to further rate hikes, warning that inflation is expected to remain above the BOK's 2 percent target for an extended period as cost pressures continue to pass through to consumer prices.

"One point we particularly take into account is that inflation hurts low income and vulnerable groups the most," Shin said in response to a question from Rep. Yoon Hu-duk of the ruling Democratic Party of Korea about possible rate hikes at the BOK's October and November policy meetings.

"The timing and pace of any further rate increases will depend on inflation and economic growth trends, as well as financial stability conditions," he said.

The governor also acknowledged that monetary tightening places a heavier burden on vulnerable households, as borrowers from lower income groups are hit harder by rate hikes.

The audit also saw opposition lawmakers question whether the government's expansionary fiscal policy would undermine the BOK's efforts to curb inflation through monetary tightening.

"Expansionary fiscal policy puts pressure on prices and the money supply in the short term," said Rep. Lee Jong-wook of the main opposition People Power Party.

Higher interest rates are intended to cool the economy by making borrowing more expensive and discouraging spending and investment. An expansionary fiscal policy, however, can have the opposite effect by injecting money into the economy and supporting demand.

In response, Shin said the BOK was using economic models to assess whether the two policies would work against each other.

He estimated that the government's budget proposal for next year would boost Korea's economic growth by 0.5 percentage point while adding 0.06 percentage point to inflation.

"If potential growth rises over the medium to long term, the two policies may not necessarily work against each other," Shin said.