Widening interest rate gap with US raises questions about BOK's rate goal

The Korea Times

The Korea Times

Finance

Sun, October 1, 2023 | 05:37

Economy

Widening interest rate gap with US raises questions about BOK's rate goal

Posted : 2022-12-15 16:03

Updated : 2022-12-16 16:27

Deputy Prime Minister and Minister of Economy and Finance Choo Kyung-ho, second from right, poses with Bank of Korea (BOK) Governor Rhee Chang-yong, second from left, Financial Services Commission (FSC) Chairman Kim Joo-hyun, right, and Financial Supervisory Service (FSS) Governor Lee Bok-hyun during an emergency meeting on macroeconomic issues at the Bankers' Club in Myeong-dong, central Seoul, Thursday. Yonhap

By Yi Whan-woo

The interest rate gap between Korea and the United States has widened to a more-than-22-year high, raising questions about whether the Bank of Korea's (BOK) policy rate will be able to settle at its target of 3.5 percent in 2023.The borrowing rate of the U.S. was raised to the range of 4.25 percent to 4.5 percent following the Federal Reserve's 50-basis-point hike, Wednesday, which is significantly more than that of Korea at 3.25 percent.

This maximum 1.25-percentage-point gap between the U.S. and Korea is the highest since Oct. 5, 2000, when the U.S led Korea 6.5 percent to 5.25 percent in their respective benchmark interest rates.

Against this backdrop, the Fed's median forecast, which was also released on Wednesday, showed that the U.S. central bank will continue to raise its policy rate to as high as 5.1 percent in its efforts to bring down inflation.

If realized, the U.S. interest rate will be 1.6 percentage points higher than Korea's, assuming that the BOK's target rate of 3.5 percent remains unchanged.

The BOK's target rate has been set as cash inflow into banks due to high interest rates has caused refinancing burdens among businesses in the debt market in Seoul.

Moreover, the reversal in the Korea-U.S. interest gap has caused negative investor sentiment in Seoul, resulting in capital flight from the stock market in search of safe haven assets as well as the weakening of the Korean won against the U.S. dollar.

While the 50-basis-point increase was within market expectations in Seoul, the Fed's median forecast was higher than the 4.6 percent projected by the Fed in September.

Correspondingly, the Korean currency weakened to the 1,300-won level against the dollar. Won ended at 1,303.1 won against the dollar, weakening by 6.8 won from the previous session.

The benchmark KOSPI also retreated Thursday, closing at 2,360.97, down 1.6 percent from the previous day, as foreign investors offloaded shares.

"Under the circumstances, the BOK may be pressed to deliver up to two rate hikes next year although it does not want to see the key interest rate rising above 3.5 percent," Hanyang University economics professor Lee Jung-hwan said.

A 25-basis-point rate hike has been the smallest increase delivered by the BOK, meaning that the base rate will rise higher than 3.5 percent if it is increased more than once from the current 3.25 percent.

Cho Young-moo, an economist at the LG Economic Research Institute, voiced a similar view.

"Whether the BOK can cease its rate hikes at 3.5 percent is uncertain considering that the interest rate gap with the U.S. keeps widening," he said. "The BOK is likely to embrace a credit tightening policy and possibly raise the borrowing rate to 3.75 percent in the first quarter of 2023."

Meanwhile, Korea's top economic policy maker and top central banker said, respectively, that they will closely monitor the market in relation to the impact of the Fed's latest rate hike and the Korea-U.S. interest gap.

"We should not let our guard down even though the Fed's latest hike was within market expectations and the pace of monetary tightening appears to be slowing down," Deputy Prime Minister and Minister of Economy and Finance Choo Kyung-ho said during an emergency meeting on macroeconomic issues in Seoul.

"The financial market is stabilizing but uncertainties still remain high with regard to inflation, growth slowdown and the tightening of monetary policy in the major economies," Choo added.

The meeting was also attended by BOK Governor Rhee Chang-yong, Financial Services Commission (FSC) Chairman Kim Joo-hyun and Financial Supervisory Service (FSS) Governor Lee Bok-hyun.

Rhee said that concerns over U.S. credit tightening have been "placated to some extent."

Nevertheless, he noted, "It should not be ruled out that volatility can surge again in the financial market depending on inflation in the U.S. and other major economies, changes in global market expectations toward those economies and the fear of a possible global recession."

yistory@koreatimes.co.kr