Following Fed's 75bp Funds Rate Hike
Goldman Sachs has revised up its forecast for Bank of Korea’s terminal policy rate to 2.75 percent from 2.5 percent previously and brought forward the peak timing to November from May 2023, on accelerated Fed tightening, higher oil prices and a recent weakening of the Korean won against the U.S. dollar.
The U.S. investment bank released the revised policy rate trajectory in a report on Korea on June 16, following the U.S. Fed's hike of its policy rate by 75bp at its meeting on June 15. The revised trajectory entails a 25bp hike each at the remaining four MPC meetings this year, instead of two intermittent 25bp hikes for the remainder of this year.
Goldman Sachs said it believes that current swap market pricing of 4.2 percent for 3-month rates on a 9-month forward basis continues to overprice a likely scope for policy rate hikes in Korea, discounting rising risks to Korea’s growth from stagnating exports and adverse impact of rapid hikes on consumption given Korea’s large household debts of 215 percent of disposable income.
Goldman Sachs said its U.S. team expects the FOMC to raise the funds rate to a peak of 3.25-3.5 percent by end 2022, up from 3.0-3.25 percent previously, including another 75bp hike at its July meeting. Its European team has also revised up its view for the ECB policy rate to a peak rate of 1.75 percent in Q2 2023.
In light of the acceleration in monetary tightening in major central banks, it added 2.25bp to its BOK's terminal rate forecast to 2.75% from 2.5% and bring forward the timing of reaching the peak level to November this year from Q2 next year, through a 25bp hike each at the remaining four MPC meetings in July, August, October and November.
The policy rate view change also reflects a likely further rise in inflation pressures
from higher oil prices, sustained upside surprises in headline inflation, and a recent weakening in the Korean won against the U.S. dollar amid a turn in global financial markets to risk aversion.
Goldman Sachs' new inflation forecasts based on its bottom-up model are 4.8 percent for 2022 and 3.1 percent for 2023, assuming limited administered price hikes.
A key driver of lower inflation next year is a projected decline in import prices, which have already been declining and are likely to continue, barring another global event that would create supply shocks. The Korean won's expected appreciation would also help reduce imported inflation. The U.S. investment bank forecasts that Korea’s policy rate will remain within a historical range of 50-75bp vis-a-vis the Fed funds rate.
Goldman Sachs believes that markets continue to overprice a likely scope for policy rate hikes by the Bank of Korea. Recently, 9-month forward rates for a 3-month CD rate have jumped to 4.2 percent from around 3.2 percent after the last MPC meeting in late May. In its view, downside risks to export growth have increased on sharp moderation in exports of goods and on the prospect of further acceleration in monetary tightening in Korea’s major trade partners.
A rapid rise in the BOK policy rate to well above 3.5 percent in early next year, as reflected in market rates, would weigh heavily on private consumption given high levels of household debts in Korea, which stand at 215 percent of net household disposable income for end-2021, among the highest in the world including 101 percent for the U.S., 135 percent for Singapore and 203 percent for Australia.