Bank of Korea Hikes Rate

South Korea became the first major Asian economy to raise interest rates Thursday, with more hikes in the pipeline as its central bank indicated that financial risks pose a bigger threat to the economy than the latest virus outbreak.

Governor Lee Ju-yeol said the quarter-percentage-point hike to 0.75% still left rates in an accommodative position that supports the economy. He added that the current delta wave is having less of a negative impact on growth as consumers adjusted behavior to the new normal of the pandemic.

Policy adjustments over the coming months would be gradual, with the timing of the next move taking into account Covid-19 developments, financial imbalances and moves by other central banks including the Federal Reserve, he said.

The move shows the focus of monetary policy in Korea has pivoted from propping up the economy to curbing a debt-driven asset bubble. Lee’s comments will give central bankers, investors and market watchers food for thought as they await Fed chair Jerome Powell’s Jackson Hole speech for clues on how and when the U.S. might shift its policy.

“We’ve decided to put the focus on reducing financial imbalances, and as we raise the rate, we are embarking on a process of normalizing policy in line with economic recovery,” Lee said. The BOK “won’t either rush or hesitate” in raising rates further, Lee said, adding that the Fed moves are a “particularly” important factor in policy considerations.

South Korea’s bond futures reversed earlier losses to rise as Lee said board member Joo Sangyong voted against the decision, tamping down bets for a back-to-back hike at the next meeting in October. The won weakened 0.3% against the dollar to 1,171.25 as of 1:04 p.m. in Seoul.

In line with Lee’s view that the economy would hold up under the latest surge of virus cases, the BOK kept its growth forecast for the year at 4%, expecting consumption to improve along with rising vaccinations and an extra budget, while exports and investment remained strong. But it also raised its inflation outlook above its target to 2.1% and highlighted accelerating household loan growth.

The bank said it based its projections on the current outbreak easing from October, allowing restrictions to be relaxed. “The BOK just couldn’t wait any longer when it has consistently stressed its focus on household debt and financial imbalances,” said Kim Sanghoon, a fixed-income strategist at KB Securities Co. “It’s not like the economy is plunging amid the latest virus wave, but household debt is something that can’t be ignored any more.”

The bank’s step toward normalization contrasts with the hesitancy of the Reserve Bank of New Zealand to increase borrowing costs last week as the country headed back into a lockdown.

Korea was also the region’s front runner in tightening in 2017, following a series of rate increases by the Fed. Compared with then, the BOK’s shift now comes before the Fed’s tapering, another indication of the level of concern among local policy makers to bring overheating markets to heel.

Recent data suggest the Korean economy has largely held up amid a surge in local and global delta cases. Exports have rallied so far in August, business confidence has strengthened and optimism still prevails among consumers.

Household debt has soared along with home prices amid pandemic

Meantime, policy makers have become increasingly troubled by the prospect of financial imbalances destabilizing the economy, with the presidential chief of staff for policy joining the drumbeat of warnings. Household debt growth is setting new records, adding fuel to an already overheated housing market and other assets.

Rate increases that help rein in asset price gains while leaving the recovery unruffled could help regain some support for President Moon Jae-in’s party if they are seen as dovetailing with government measures. A presidential election is due next spring and unaffordable housing is one of the key factors that has drained support from Moon’s administration.

What Bloomberg Economics Says…

“In our view, the BOK will need to proceed cautiously, given enduring virus risks and the need to minimize the impact of higher borrowing costs on indebted households. We expect it to hold rates through year-end.”

— Justin Jimenez, Asia Economist

For the full report, click here.

Governor Lee said higher rates would inevitably weigh on demand for loans, but that alone won’t curb housing prices, which are also affected by government policy, supply and demand in the market, and price expectations.

“The BOK decision can turn the heads of other central banks and reinforce the perception that asset bubbles and their impact on wealth divides are a very important issue,” said Park Chong-hoon, an economist at Standard Chartered Bank in Seoul. “This first move can be seen as a signal for other countries to follow.”

The BOK has two more rate decisions left for this year. Lee’s second term as governor ends March 2022.