Central Bank Hikes Interest Rate to 1.75%

The Bank of Korea on Thursday raised the key interest rate by a quarter percentage point to 1.75 percent. It was the second hike in as many months.

The aim is to tame inflation, which has soared to the four-percent level. It was BOK Governor Rhee Chang-yong's first Monetary Policy Committee meeting since he took the job.

The central bank slashed the key rate to a record-low 0.5 percent after the coronavirus pandemic erupted, but raised it cautiously in August and November 2021 and January, April and May this year to the highest level in almost three years.

Rhee hinted at further hikes ahead this year. Asked if he felt a rate of between 2.25 percent and 2.5 percent is reasonable, he said, "I believe that is a reasonable expectation, since the inflation forecast has risen."

"We will decide monetary policy based on forecasts for consumer prices for the next several months," he told reporters.

Consumer prices increased 4.8 percent in April, which was the highest since October 2008, and are expected to surpass five percent this month. "At present, we have to be more worried about increasing inflation than stagflation. We cannot rule out inflation rising until the middle of this year... and remaining in the four-percent range until early next year."

The central bank has already slashed its economic outlook for the year from three percent to 2.7 percent and raised the inflation forecast from 3.1 percent in February to 4.5 percent this year.

"Even if oil prices drop, international grain prices are rising [because of the war in Ukraine] and consumer prices will stay high for a considerable amount of time," Rhee added.

The BOK needs to follow the U.S. Federal Reserve's steep rate hikes because if the interest rate gap narrows or reverses, the threat of a capital flight out of Korea rises. Aiming to suppress inflation in the U.S., which soared to the eight-percent level for the first time in 41 years, the Fed hiked the interest rate by half a percentage point on May 4 to a range of 0.75 to one percent, and there is a strong chance of further increases.

But Rhee said, "Korea is one of the few countries where foreigners buy bonds, so the chance of a capital flight remains low."

Loan interest rates are expected to rise apace, which means that households that borrowed heavily to buy their own home will start to feel the pinch. "If we raise the key rate by a quarter percentage point, households will have to shoulder an additional interest burden of W3 trillion and businesses W2.7 trillion," he added (US$1=W1,264).