Bank of Korea Senior Deputy Governor Yoo Sang-dae said, "The time has come to stop cutting rates and consider raising them." As an ex-officio member of the Monetary Policy Board that determines interest rates, the BOK deputy governor publicly referenced a rate hike for the first time since the outbreak of the Middle East war.
Yoo held a press briefing on the sidelines of the Asian Development Bank (ADB) annual meeting in Samarkand, Uzbekistan, on the 3rd (local time), saying, "Prices are rising more than expected, and there is a possibility of shifting to a hiking cycle."
The Bank of Korea (BOK) cut rates four times from October 2024 through May of last year, then held them steady for the following year. In January, it signaled an end to the rate-cutting stance but has not yet indicated a rate hike. However, with inflationary pressure mounting from high oil prices due to the Middle East war, and growth not expected to fall sharply below forecasts, the BOK has signaled a pivot toward a rate-hiking stance.
"Until late last year, the mood was that we could end the cutting cycle after one more reduction, but the situation changed following the outbreak of the Middle East war, adding to our concerns," Yoo said. "Compared with the April rate freeze, growth is unlikely to fall significantly below 2.0 percent, while inflation is now more likely to exceed 2.2 percent."
The direction of the BOK's monetary policy is expected to become clearer at the Monetary Policy Board meeting on the 28th of this month. The dot plot, which shows board members' rate forecasts six months ahead, is also more likely to be revised upward. "There is room for both the upper bound and the average to rise compared with the February dot plot," Yoo said.
In the market, expectations are shifting beyond a single hike this year toward as many as two hikes. "Currently, a path of up to two or more hikes within the year is being discussed," said Yoon Yeo-sam, research fellow at Meritz Securities.
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BOK Senior Deputy Governor Yoo Sang-dae's public formalization of a rate-hiking stance on the 3rd (local time) is interpreted as a response to mounting upward pressure on domestic prices in the wake of the Middle East war.
Yoo explained that domestic prices are facing considerable upward pressure despite the government's various policies, including a ceiling on oil prices. With oil prices and the exchange rate rising simultaneously due to the Middle East war, the need for preemptive monetary tightening has grown.
Indeed, major overseas institutions are uniformly revising upward their inflation forecasts for Korea this year. JPMorgan raised its forecast by 1 percentage point, from 1.7 percent in March to 2.7 percent last month, while Bank of America Merrill Lynch raised its inflation outlook by 0.8 percentage point, from 2.1 percent to 2.9 percent.
The market particularly notes that Yoo mentioned a rate hike just before the April consumer price index release on the 6th. While March consumer price inflation was only 2.2 percent, April is expected to come in at the mid-to-high 2 percent range as oil price gains are fully reflected. "There appears to be an intention to stabilize the market by signaling a rate hike before the 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 unexpectedly strong also appear to have played a role. Although concerns about stagflation (inflation combined with economic stagnation) initially emerged due to the Iran war, major overseas investment banks (IBs) have successively raised their growth forecasts for Korea this year on the back of the semiconductor super cycle and strong domestic demand following the execution of a supplementary budget. According to Bloomberg data, U.K. research firm Capital Economics at the end of last month projected Korea's growth rate this year at 2.7 percent. This is 1.1 percentage point higher than its forecast a month earlier (1.6 percent). JPMorgan Chase also recently presented 3.0 percent, up 0.8 percentage point from its previous forecast (2.2 percent).
Domestically, if Korea's first-quarter growth this year, announced last month, is maintained at 1.7 percent (preliminary figure), annual growth could reach 2.4 to 2.5 percent even if quarterly growth (quarter-on-quarter) averages around 0 percent for the rest of the year. This means real growth could exceed potential growth, potentially turning the GDP gap positive. Korea's potential growth rate is currently estimated at below 2 percent. This is why analysts believe the real economy is unlikely to contract sharply even if the BOK raises its base rate.
As a result, market attention is focused on when the BOK will implement the rate hike and how many hikes will occur within the year. Considering that Yoo mentioned the BOK would send a hike signal at the May Monetary Policy Board meeting, most experts expect a rate hike in July followed by one additional increase within the year.
"Under current conditions, up to two hikes could be implemented within the year," said Yoon Yeo-sam, research fellow at Meritz Securities. "I expect one hike in the third quarter and another in the fourth quarter, bringing the final base rate this year to around 3 percent."
Meanwhile, Korean treasury bond yields jumped across the board on the 4th after BOK Senior Deputy Governor Yoo Sang-dae mentioned the possibility of a base rate hike.
In the Seoul bond market that day, the yield on three-year treasury bonds closed at an annual 3.615 percent, up 0.02 percentage point from the previous trading session. The 10-year yield rose 0.009 percentage point to 3.932 percent.
Early in the session, treasury bond yields opened lower, supported by declining international oil prices and news that Iran had presented a new negotiation proposal to the United States. However, as Yoo's remarks made during the session were reported, yields reversed course and all rose.
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