BOK Freezes Interest Rates for Another Month

The Bank of Korea on Thursday kept the base interest rate unchanged at 3.5 percent as inflation is slowing down while concerns grow of an economic slump.

It was the fourth straight freeze after February, April and May despite a strong chance that the Federal Reserve will raise U.S. interest rates at the end of this month, which will widen the rate gap between the two countries to two percentage points.

But all six members of the BOK's monetary policy committee supported a freeze. Their main rationale was that inflation fell to 2.7 percent last month, down from 6.3 percent last year after Russia's invasion of Ukraine. It was the first time since September 2021 that inflation fell below three percent.

The freeze was widely expected, but there are fears that the wider the interest rate gap between Korea and the U.S., the more likely foreign investors are to exit Korean stock and bond markets in search of higher returns elsewhere, causing the won to weaken as they exchange it for dollars.

At present, the U.S. federal funds rate stands at five to 5.25 percent, 1.75 percentage points higher than Korea's, and the Fed is highly likely to raise it by another quarter percentage point later this month in order to tame inflation further, which fell to three percent in June.

Not everyone believes foreign investors will pull out of Korea and the won will weaken. A recent report by the Korea Capital Market Institute showed not a single instance of foreign investors existing the Korean financial market during four periods when the U.S. interest rate was higher than Korea's -- January 2000 to March 2001, August 2005 to September 2007, March 2018 to February 2020 and July 2022 to June 2023.

But others say the interest rate reversal this time is different than the past since the gap has never been more than 1.5 percentage points, while a difference of more than two percentage points is unprecedented.

Sung Tae-yoon at Yonsei University said, "It's not normal for the won to hover at around W1,300 against the dollar, and the interest rate gap between the U.S. and Korea seems to be the reason."

BOK Governor Rhee Chang-yong said, "We left open the possibility of an additional rate hike to 3.75 percent."