Bank of Korea Deputy Governor Ryoo Sang-dai's public confirmation of a rate-hike stance on Tuesday (local time) reflects mounting domestic inflationary pressure from the fallout of the Middle East war. Market participants expect the BOK to raise rates as early as July, followed by another hike that would bring the benchmark rate to 3% by year-end.
Ryoo explained that despite the government's various policies, including an oil price ceiling system, domestic prices are facing substantial upward pressure. With oil prices and the exchange rate rising simultaneously due to the Middle East war, the need for preemptive monetary tightening has grown.
Major foreign institutions are uniformly raising their inflation outlook for Korea this year. JPMorgan lifted its forecast by 1 percentage point to 2.7% last month from 1.7% in March, while Bank of America Merrill Lynch raised its inflation projection by 0.8 percentage points to 2.9% from 2.1%.
The market is particularly focused on the fact that Ryoo mentioned a rate hike ahead of the April consumer price trend release on Friday. While March consumer price inflation stood at 2.2%, April is projected to show readings in the mid-to-high 2% range as oil price gains are fully reflected. "There appears to be an intent to stabilize the market by sending a rate-hike signal before statistics showing a surge in consumer prices are released," a bond market official said.
Expectations that this year's gross domestic product (GDP) growth will be better than anticipated also appear to have played a role. While concerns about stagflation — economic recession combined with inflation — initially emerged due to the Iran war, major foreign investment banks (IBs) have been successively raising their growth forecasts for Korea this year, citing the semiconductor super cycle and strong domestic demand from supplementary budget execution. According to Bloomberg data, British research firm Capital Economics presented a 2.7% growth forecast for Korea this year at the end of last month. This is 1.1 percentage points higher than its forecast a month earlier (1.6%). JPMorgan Chase also recently presented 3.0%, raising its projection by 0.8 percentage points from its previous forecast (2.2%).
Domestically, if Korea's first-quarter growth rate released last month maintains 1.7% (preliminary), projections indicate that annual growth could reach 2.4-2.5% even if the average quarterly growth rate (quarter-on-quarter) for the remaining period stays at around 0%. This means there is a possibility that the GDP gap could turn positive as real growth exceeds potential growth. Korea's current potential growth rate is estimated at below 2%. This is why analysts say that even if the BOK raises the benchmark rate, there is little possibility that the real economy will contract sharply.
Accordingly, market attention is focused on when the BOK will implement rate hikes and how many times it will raise rates this year. Considering Ryoo's remarks about signaling a hike at the May Monetary Policy Board meeting, most experts expect the BOK to raise rates in July and hike once more within the year.
"Based on the current inflation forecast path, a July hike appears likely, and with one more increase in October or November, the year-end benchmark rate is expected to reach around 3%," Kim Sung-soo, a researcher at Hanwha Investment & Securities, said. Ahn Dong-hyun, a professor of economics at Seoul National University, said, "If the BOK is concerned about inflation, a 0.25 percentage point hike at this month's Monetary Policy Board meeting cannot be ruled out," adding, "If inflationary pressure continues thereafter, an additional hike in the second half could be considered while monitoring domestic demand trends."
Some view Ryoo's remarks as merely a signal, saying it remains to be seen whether they will lead to an actual rate hike. "If the Middle East war does not become prolonged, prices could stabilize within three to four months," Kang Sung-jin, a professor of economics at Korea University, said. "Since the Korea-U.S. rate gap also remains large, the BOK could move while watching the U.S. Federal Reserve's trajectory."
