The Korean central bank on Thursday raised interest rates for the first time in more than six years in line with expectations as the pickup in the economy allowed it to join forces with financial authorities to contain snowballing household debt.
The move after inaction of 16 months does not suggest a shift in the “accommodative” monetary stance, said Bank of Korea (BOK) Governor Lee Ju-yeol in a press conference after the rate decision meeting.
The BOK’s Monetary Policy Committee meeting for the last time this year on Thursday decided to raise the base rate by a quarter of a percentage point to 1.50 percent from the record low of 1.25 percent kept since June last year. The late time the base rate was raised was in June 2011. There was one dissenting vote in the seven-member board against a hike.
“It is not appropriate for the market to predict one or two additional hikes next year,” he said, adding that further hikes would come after “prudent judgment” based on “thorough study of the trends in growth and inflation.”
He reiterated that the bank won’t match U.S. rate normalization pace as Korea’s monetary policy should first consider the rate impact on the Korean economy and financial market.
“Our policy will depend on the solidness in growth and inflation nearing the (2.0 percent) target,” he said.
Markets expected the central bank would have to make a preemptive move ahead of an anticipated rate hike by the U.S. Federal Reserve in December. Once the Fed makes a 25-basis-point hike next month, the U.S. federal funds rate target would be in a range between 1.25 percent and 1.50 percent.
His comments on Thursday reversed the mood in the market that has been betting on additional hikes next year after the International Monetary Fund bumping up Korea`s growth estimate for this year to 3.2 percent in its latest review suggested that Korea can afford two more hikes while staying accommodative of the economy.
He predicted the rate hike won’t likely accelerate strengthening in the won as the foreign exchange rate moves in the context of various factors - external conditions, geopolitical risks, and inflationary pressure.
On Thursday, the benchmark three-year bond yield slipped 3.7 basis points to 2.075 while five-year yield declined 4.1 basis points to 2.262. The main Kospi fell 1.45 percent and ended the day at 2,476.37. Korean currency closed at 1,088.2 won against the U.S. dollar, down 11.4 won from the previous session’s close.
He reiterated that the central bank will act if “the foreign exchange volatility is deemed excessive.”
Bank of Korea Governor Lee Ju-yeol whose term ends in March next year administered a rate hike for the first time in his four-year term. He has been warning the market since summer that the interest rates would have to be lifted from the record-low level sooner or later as too lengthy easing can build up bubbles.
The Korean economy grew at the faster-than-expected pace of 1.4 percent in the third quarter, raising expectations that the GDP growth would meet the BOK’s annualized growth target of 3.0 percent. Inflation is also expected to hover within the 2017 target of 2.0 percent as private consumption improved. Job additions picked up while the unemployment rate declined in the previous month.
Still, the BOK isn’t likely to move fast to raise interest rates as the recovery pace remains uncertain and inflation excluding volatile food and oil prices subdued. Industrial activity softened in October with manufacturing output as well as consumer and corporate spending weakening in data released by the Korea Statistics Thursday.
The same reason weighs on the U.S. Federal Reserve which had targeted to normalize rates to 2 percent next year and 3 percent in the following year as policymakers are wary that inflation could stay below the 2.0 percent target for a lengthy period despite the recovery in the economy.
Slower hike move by the U.S. also could give the BOK more policy maneuvering room until the recovery becomes more solid and leveraged households less risky.
Authorities cannot risk an upset in the explosive household debt if interest rates go up higher too fast. By the end of September, household debt in Korea hit a new historic high of 1,419.1 trillion won ($1.3 trillion), a figure tantamount to the country’s total gross domestic product. Annual interest payment would go up by 2.8 trillion won after reflecting the 25-basis-point hike in the base rate.
By Park Joon-hyung and Cho Jeehyun
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