A four-year-old Bank of Korea (BOK) blog post arguing that the central bank must preemptively raise interest rates to curb inflation expectations is drawing renewed attention. Analysts say BOK Senior Deputy Governor Yoo Sang-dae's unusual signal of a potential rate hike in the second half of this year reflects the central bank's concerns about responding preemptively to rising prices.
In July 2022, the BOK published a post titled "Why Monetary Policy Must Respond to Price Increases Driven by Global Commodities," under the name of Hong Kyung-sik, then director general of the monetary policy department. The post stated, "When surging oil prices spill over into price increases for other items, inflation expectations among economic actors such as households and businesses also rise sharply." It added, "In this case, inflation becomes not a temporary but a persistent phenomenon." The post was written in 2022, when commodity prices including oil soared due to the Russia-Ukraine war, consumer prices surged, and the benchmark interest rate was being raised. At the time, counterarguments emerged, including "Does raising interest rates bring down oil prices, or does it only trigger a recession?" Concerns were also raised that quarterly gross domestic product (GDP) could contract from the second half of that year due to factors such as the war.
In response to such criticism, the BOK explained at the time, "If the central bank dismisses this as a supply-shock-driven price increase and fails to respond in time, inflation will accelerate, and larger rate hikes will become inevitable to stabilize prices going forward." It further argued, "If inflation intensifies, households' total income will decline sharply, making a recession unavoidable."
The BOK's conclusion was that preemptively raising rates and stabilizing inflation expectations would allow prices to stabilize early, enabling the economy to return to a growth trajectory more quickly.
Yoo's recent remarks about a possible shift to a rate-hiking cycle are interpreted in the same context. Indeed, consumer inflation expectations have surged following the Iran war. According to the BOK, consumers' one-year inflation expectations rose to 2.9% in the April consumer survey, up 0.2 percentage point from the previous month. The five-year inflation expectation also rose 0.1 percentage point to 2.6%, exceeding 2.5% for the first time since November last year.
Lee Seung-hoon, an economist at Meritz Securities, said, "It appears to raise the need for a preemptive response before inflation expectations further drive up price pressures like a self-fulfilling prophecy."
The market expects the BOK to signal a rate hike at the Monetary Policy Board meeting on the 28th of this month and to raise rates as early as July or August. Some forecasts suggest two rate hikes in the second half of the year if inflation pressures from the Iran war fallout do not subside.
