An Unprecedented Rate Hike

Bank of Korea Governor Lee Chang-yong (center) presides over a Monetary Policy Board meeting on July 13.

The Monetary Policy Board of the Bank of Korea raised the key interest rate by an unprecedented 0.5 percentage point to 2.25 percent on July 13.

The board described its action as a pre-emptive policy response aimed at preventing the entrenchment of high inflation. It said high inflation is continuing and becoming broad-based, while short-term inflation expectations are rising sharply. It said a pre-emptive response is of greater importance at this time, although economic downside risks have increased at home and abroad.

The following is the full text of the bank's statement on its monetary policy decision:

The Monetary Policy Board of the Bank of Korea decided today to raise the Base Rate by 50 basis points, from 1.75 percent to 2.25 percent. The Board judges that a pre-emptive policy response to prevent the entrenchment of high inflation is of greater importance for some time as high inflation is continuing and becoming broad-based while short-term inflation expectations are rising sharply, although economic downside risks have increased at home and abroad.

Currently available information suggests that global economic growth has weakened, affected by the prolonged Ukraine crisis, while inflation has remained high. In global financial markets, risk aversion has strengthened due to the acceleration of policy rate hikes in major countries and consequent concerns about economic slowdown. The U.S. dollar has remained strong and stock prices have fallen considerably, while government bond yields in major countries have fluctuated significantly. Looking ahead, the Board sees global economic growth and global financial markets as likely to be affected largely by global inflation movements, monetary policy changes in major countries, geopolitical risks, and COVID-19 restrictions in major countries.

The Korean economy has continued to recover. Private consumption has sustained its improvement and sluggishness in facilities investment has eased, while export growth has somewhat slowed. Labor market conditions have continued to improve, with the year-on-year increase in the number of persons employed remaining high. Going forward, while private consumption is likely to sustain its recovery, GDP growth this year is projected to be somewhat below the May forecast of 2.7 percent, affected by the slowdown in exports owing to weakening of economic growth in major countries. Uncertainties surrounding the economic outlook are judged to be elevated.

Consumer price inflation has risen significantly to 6.0 percent due to the ongoing sharp rise in the prices of petroleum products and the accelerating price increases in other expenditure categories. Core inflation (excluding changes in food and energy prices from the CPI) and the inflation expectations of the general public have increased to close to 4 percent. It is forecast that consumer price inflation will remain high at above 6% for some time and run substantially above the May forecast of 4.5 percent for the year overall. Core inflation is forecast to remain elevated at 4 percent or higher for a considerable time.

In domestic financial markets, long-term market interest rates have risen considerably, due to expectations about policy rate hikes at home and abroad, while stock prices have fallen sharply driven mainly by concerns about global economic slowdown. The Korean won to U.S. dollar exchange rate has risen significantly, reflecting the global strengthening of the U.S. dollar. Household loans have increased slightly and housing prices have remained steady.

Considering inflation and economic conditions, though economic downside risk is indeed high, uncertainties remain elevated, and thus the Board sees it as important at this time to curb the spread of inflation expectations through a 50-basis-point rate hike to prevent acceleration of inflation.

The Board will continue to conduct monetary policy in order to stabilize consumer price inflation at the target level over a medium-term horizon as it monitors economic growth, while paying attention to financial stability. The Board sees continued rate hikes as warranted, as inflation is expected to run above the target level for a considerable time. In this process the Board will determine the size and pace of further increase of the Base Rate while thoroughly assessing the trends of growth and inflation, the risk of a buildup of financial imbalances, monetary policy changes in major countries, and external economic conditions including geopolitical risks.

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