The Bank of Korea has raised the benchmark interest rate by 0.25 percentage points to 1.75 percent, the first hike in a year since November last year.
The central bank held a plenary session of the Monetary Policy Committee on Nov. 30 and announced that it would raise the benchmark interest rate from 1.50 percent per year to 1.75 percent. This is the first increase since the bank raised the key rate by 0.25 percentage points in November last year, the first increase in six years and five months.
The central bank sent early signs of an increase, citing financial stability. According to a recent survey of 12 economic and financial experts, 11 people, excluding one, predicted a rate hike. In a survey of 200 employees of 106 institutions related to bond investment by the Korea Financial Investment Association (KOFIA), 79 percent of respondents forecast an increase.
One important reason for the increase is the massive household debt, which is weighing heavily on the economy. Under the low interest rate, the household debt has excessively accumulated, putting a dent in the macro economy, including consumption. This is an example of financial imbalance that the central bank thinks needs to be addressed.
Currently, household debts amount to 1,514.4 trillion won. The growth rate for the third quarter of this year was 6.7 percent (compared to the same period last year), which is higher than the income growth rate. Last year, the nominal disposable income growth rate of households and non-profit organizations was 4.5 percent.
The widening interest rate gap between Korea and the United States is also one of the reasons for the increase. This is another aspect of the financial imbalance. The U.S. Federal Reserve's benchmark interest rate is 2.00 to 2.25 percent per year. The Fed is likely to raise interest rates again next month. If the BOK had frozen interest rates on Nov. 30, the reversal would have widened to 1 percentage point next month. A widening interest rate gap with the U.S. would hurt Korea’s financial stability.
The rate hike reflected the monetary authorities’ view that financial stability should be put before economic performance now, said an economist at Daishin Securities Co.
Another reason is that the Bank of Korea thinks the Korean economy is growing at its potential growth rate. The central bank forecasts 2.7 percent growth this year. The bank's estimate of Korea’s potential growth rate, which was disclosed in July last year, is 2.8 percent to 2.9 percent. The Bank of Korea believes that this year`s growth forecast is also in the path of potential growth.
Consumer prices are also close to the target rate of 2.0%. In September and October this year, the figure rose 1.9 percent and 2.0 percent year-on-year, respectively.
After announcing the rate hike, the BOK said in a statement, "The Monetary Policy Committee will maintain its accommodative monetary policy stance. It will see whether it is necessary to further adjust its accommodative stance, while closely monitoring future economic growth and inflation trends."
BOK Gov. Lee Ju-yeol stressed that Korea's policy rate is still low enough that it can be called "expansionary." He said despite the rate hike, Korea's benchmark rate is still below the neutral rate of interest.