Basic Rate Frozen
The Bank of Korea (BOK) chose to freeze the benchmark interest rate in a dilemma where pressure was mounting to maintain a basic easing tone and switch to retrenchment at the same time.
On July 13, the BOK decided to freeze the benchmark interest rate at 1.25% at the current level in a plenary session of the Monetary Policy Committee of July presided over by governor Lee Ju-yeol. Accordingly, the benchmark interest rate would remain at the same level for the 13th month after falling 0.25 percentage points from 1.50 percent to 1.25 percent in June.
At present, the Bank of Korea is receiving both relaxation and tightening pressures. Considering a negative GDP gap that the actual GDP growth rate is below the potential growth rate, it is necessary to maintain an easing monetary policy. The BOK estimates that the potential growth rate in Korea is less than 3%, and believes that the negative GDP gap will be maintained until 2018.
The concern over an increase in household debts is a factor that can kindle an interest rate hike. This is because there is criticism that as a basic low interest rate tone became prolonged, real estate speculation occurred and finally household debts amounted to 1.4 quadrillion won (US$1.26 trillion). Some experts claim that considering a possibility of financial instability, it is now time to raise the benchmark rate.
The decision to freeze interest rates in this dilemma situation is interpreted as putting more weight on the economic situation, such as domestic consumer prices. In a meeting of the Monetary Policy Committee regarding the financial stability report on March 22, a member of the Monetary Policy Committee said, "The government's macro-prudential policy should be used first rather than raising the interest rate in the preparation of household debts." This statement hinted at why the decision was made. Moreover, the government announced that it will unveil general measures to tackle household debts in August, which seemed to affect the decision-making.
The US Fed's emphasis on a "gradual interest rate hike" is the basis for the BOK to maintain a basic easing tone for the time being. The Fed raised its policy interest rate 0.25 percentage points to 1.25 percent from 1.25 percent.
"There is a debate about gradually increasing the interest rate at the US Fed considering the inflation rate so Korea has no choice but to freeze the rate,” said Seong Tae-yoon, a professor at Yonsei University
There are mixed forecasts about when the BOK will raise the benchmark interest rate. Most foreign investment banks (IBs) said that it would be difficult to raise interest rates within this year. Nomura picked the second half of next year after it is confirmed that central banks of major countries conducted the normalization of monetary policies. Citi predicted the first quarter of next year. CS predicted there would be no rate hike next year, too, due to a negative GDP gap.