South Korea: BOK’s policy dilemma

BOK to hike and pause at 3.5-3.75%
Group Research, Ma Tieying13 Oct 2022
    Photo credit: Unsplash Photo

    The Bank of Korea raised its policy rate by 50bps to 3.00% at yesterday’s meeting, in line with market consensus and our forecast. According to Governor Rhee, “many board members” see the terminal interest rate at “around 3.50%”. Opinions regarding the pace of tightening have become divided – two out of the seven board members voted for a smaller 25bps rate hike yesterday.

    The BOK is facing a policy dilemma. Closing rate gap with the Fed and stabilising the KRW would require the BOK to lift its policy rate to 4-5%. Taking the real rate back to a positive territory and normalising inflation would also require the BOK to lift rate above 4% (official 2023 CPI forecast: 3.7%). But growth outlook is deteriorating rapidly. Exports contracted -12.2% YoY (per working day basis) in the first 10 days of October, sharply down from 9.0% during the same period of September. The latest data also showed that property prices declined further on the sequential basis in the first week of October, reflecting the deterioration in consumer loan/home purchase demand.

    Considering all, we think the BOK will continue to hike rates but will pause at 3.50-3.75%. The market implied policy rate currently also stands at ~3.25% for the next three months and ~3.75% for the next 6-12 months. This means that the negative gap between the BOK and the Fed’s policy rate will widen to ~100bps by the end of this year. Pressure on the KRW will likely continue in 4Q, given a negative KRW-USD rate gap, large trade deficit, and prospects of a sluggish stock market.

    Ma Tieying 馬鐵英, CFA

    Senior Economist - Japan, South Korea, & Taiwan 經濟學家 - 日本, 南韓及台灣


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