BOK in Dilemma over Benchmark Rate Adjustment

The Bank of Korea is in a dilemma over the benchmark rate as the US Fed is likely to raise its key rate soon, further widening the gap between the two key rates. It is not easy for the bank to make an upward adjustment due to concerns over a domestic economic slowdown.

The Fed is likely to raise its key rate by another 0.25 percentage points at the FOMC meeting scheduled for June 12 and 13. Then, the gap is widened to 0.5 percentage points. Even so, a foreign investor exodus from the South Korean market is unlikely to occur in view of South Korea’s current account surplus and external soundness. No significant capital outflow was witnessed after the interest rate reversal in March. The volume of the outflow reached US$1.4 billion in April but an inflow of US$2.7 billion was recorded in the following month.

The real problem is that the interest rate difference can increase and continue for a while. Besides, foreign investors are currently leaving emerging markets such as Argentina, Brazil and Turkey with the values of their currencies plummeting. The same may occur in South Korea as the case may be. Under the circumstances, the Fed’s message at the upcoming FOMC meeting is drawing much attention. Impacts on emerging markets will be significant if the Fed raises its key rate while signaling that the rate can go up faster with time.

The Bank of Korea’s upcoming Monetary Policy Committee meeting is scheduled for next month. The central bank is expected to maintain the current rate at the meeting in view of the pace of economic recovery, inflation, job market conditions, etc. According to some private-sector research institutes, the South Korean economy is in the initial phase of a recession now.

Still, the Bank of Korea is in no position to delay an interest rate hike given external conditions. If the central bank maintains its key rate in July and August and the Fed raises its rate in September, the gap increases to 0.75 percentage points. Many experts point out the central bank of South Korea should raise its rate in advance before a further economic slowdown.