BOK Mulls Drastic Rate Hike

The Bank of Korea is reportedly minded to the base interest rate drastically in a monetary policy meeting next Wednesday. 

The timing is ripe to tame runaway inflation, but W1.90 quadrillion in household debt, shrinking private consumption and weakened corporate investments remain a worry as they could lead to an economic slump and job losses. 

If the BOK hikes the key rate by half a percentage point, the impact will be far greater than the usual 0.25 percentage point increase. In its 72 years of existence, the central bank has never raised interest rates by more than that. 

"The base rate needs to be raised in order to tame soaring inflation, but this could end up hurting the economy in other ways," a government official said. 

An official at the Ministry of Economy and Finance said, "We need to worry about the worst-case scenario where trying to ease the pain of rising consumer prices ends up costing jobs."  

Still, market watchers expect the BOK to take the plunge in order to prevent the U.S. benchmark rate from surpassing Korea's as the U.S. Federal Reserve is expected to raises its key rate by a half or 0.75 percentage point in its upcoming meeting after a 0.75 percent increase last month. BOK Governor Rhee Chang-yong said he will focus on taming inflation for the time being.

The won has already weakened to the W1,300 level against the dollar and an interest rate hike is necessary to prevent a further fall. So far financial authorities have released the government's dollar holdings to stabilize the won, but Korea’s foreign currency reserves fell by $9.43 billion to $438.30 billion in June, the biggest monthly decline since the 2008 global financial crisis. 

If the BOK takes a big step in this month's meeting due to the high inflation rate in June, the central bank could be forced to raise the base rate again in August if consumer prices continue surging. 

Two big jumps in a row -- a one-percentage point increase in the base rate -- would be unprecedented in such a short time, and the shock will be even greater because the economy is already reeling from pessimistic business sentiment and falling retail sales. 

Some expect that the BOK will just raise the key rate by a quarter-percentage point this month and see if it helps. Joo Won at Hyundai Research Institute said, "An interest rate hike is necessary to tame inflation, but the central bank must be careful not to take too big a leap and trigger an economic slump."