At the final Monetary Policy Committee meeting before Bank of Korea Governor Lee Chang-yong's term expires, the benchmark interest rate was frozen for the seventh consecutive time at 2.5% annually. This is interpreted as an intention to maintain the freeze and monitor future developments as uncertainty across the economy has grown in the aftermath of the Iran war.
However, the Bank of Korea forecast that due to the Middle East situation, Korea's growth rate this year would fall below 2% while inflation would surge to the mid-to-upper 2% range, signaling a revision to this year's economic outlook next month. Regarding stagflation (rising prices amid economic recession), which has recently emerged as a hot topic, the bank emphasized that while the possibility is currently small, it cannot be ruled out if Middle East risks become prolonged.
Governor Lee explained the background of the rate freeze at a briefing held immediately after the Monetary Policy Committee meeting on the 10th, stating, "Since the Middle East war, upward pressure on prices and downward pressure on growth have increased, and financial market volatility including exchange rates has expanded. We judged it appropriate to maintain the current interest rate level and monitor the situation going forward." This means the rate will remain fixed at 2.50% for more than 10 months from last July until the next meeting (May 28). This rate freeze was decided unanimously by all seven Monetary Policy Committee members.
Although rates were maintained as the market expected, the Bank of Korea's Monetary Policy Committee signaled adjustments to this year's economic growth rate and consumer price inflation rate. In its monetary policy direction resolution, the committee stated, "After the Middle East situation, economic sentiment has weakened and production disruptions have occurred in some industries, showing increased downward pressure on growth," and forecast that "despite strong semiconductor exports and the supplementary budget, this year's growth rate is expected to fall below the February forecast (2.0%)."
Regarding prices, it stated, "While upward pressure will expand significantly due to rising international oil prices, the government's price stabilization measures will partially mitigate this, and inflation is expected to rise to the mid-to-upper 2% range," and forecast that "this year's consumer price inflation rate will significantly exceed the February forecast (2.2%)." As the Bank of Korea releases revised economic statistics every February, May, August, and November, it is expected to officially adjust the figures in May.
Although concerns about economic contraction and rising prices are growing, Governor Lee said the possibility of stagflation is not high at this point. However, he stated, "It is impossible to predict what will happen two weeks after the ceasefire negotiations," and "If energy infrastructure is destroyed, the impact could become prolonged, and it is difficult to deny that stagflation could occur in a worst-case scenario."
Governor Lee signaled that he would not mechanically respond with rate hikes just because rising prices are a concern. He said, "During the Russia-Ukraine war in 2022, the war shock acted as a factor that significantly raised prices rather than slowing the economy, so there was a need to respond with rate hikes," adding, "But now, the war is affecting not only prices but also the economy, which we must keep in mind." He explained, "If the supply shock becomes prolonged, a policy response will be necessary, but if the shock is temporary, it is desirable not to respond with rate adjustments considering policy lags."
Experts also assess that Governor Lee's remarks maintained a cautious stance rather than signaling rate hikes to the market. Yoon Yeo-sam, a researcher at Meritz Securities, said, "You can sense that Governor Lee tried not to use the words 'rate hike' as much as possible," and "If the growth rate comes in slightly below 2% and inflation in the mid-to-upper 2% range as the Monetary Policy Committee indicated, the benchmark rate freeze stance is expected to be maintained this year." However, forecasts still persist that rate hikes could begin in the second half of this year once Shin Hyun-song is nominated as the next Bank of Korea Governor.
Meanwhile, regarding the government's "war supplementary budget," Governor Lee mentioned, "This supplementary budget has a positive aspect in that it was financed through excess tax revenue rather than debt." However, he pointed out, "This supplementary budget includes 4.8 trillion won in local education finance grants," and "We should consider whether sending excess tax revenue to elementary, middle, and high school education budgets is truly appropriate for the purpose of responding to economic conditions when compiling a supplementary budget."
