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Governor Lee Ju-yeol said South Korea’s central bank is preparing for an “orderly exit” from its record-low interest rate at some point as the economy recovers and financial risks mount.
Speaking after the Bank of Korea boosted its growth outlook for this year to 4% and its inflation projection to 1.8%, Lee said the central bank shouldn’t miss the timing on normalizing policy. The board still unanimously agreed to hold the key rate at 0.5% on Thursday as pandemic uncertainties linger, Lee said.
“We have eased our monetary policy to an unprecedented level, and it’s natural that we should adjust these measures as appropriate if the economic situation improves,” Lee said. “The problem is, while the economy is recovering, there are sill underlying uncertainties, so we shouldn’t be hurting the momentum.”
Lee’s step toward signaling a withdrawal of pandemic-era stimulus aligns the bank with peers in New Zealand and Canada. Still, with the coronavirus still raging across the world and most central banks pledging growth support, Lee sought to reassure investors there won’t be a premature shift in policy.
Exports and investment have led Korea’s expansion this year, lifting confidence and prompting a flurry of outlook upgrades from analysts. Economists may be bringing forward their expectations on the BOK’s likely tightening in light of the outlook upgrade.
“We think that the central bank in Korea will be one of the first ones to go, as far as rate hikes are concerned,” Deutsche Bank (DE:DBKGn) economist Juliana Lee said on Bloomberg Television.
South Korea’s 10-year bond yield erased earlier gains, falling 2 basis points to 2.11% as of 12:55 p.m. Seoul time, while the won declined 0.1% to 1,117.60 per dollar
Pandemic Uncertainties
Lee also said board members discussed whether to offer signals to markets on any policy change, and said growth could top the new 4% forecast if government adds further stimulus and vaccinations speed up. In February, the BOK saw 3% growth and 1.3% inflation for this year.
Financial markets have so far been pricing in two rate increases by the BOK over the next 12 months, a more hawkish bet than economists whose median forecast is for a hike in the third quarter of 2022.
The central bank raised its growth projections for 2022 to 3%, but kept its inflation outlook unchanged at 1.4%, which is slower than this year’s forecast.
Uncertainties related to the pandemic argue against any early tightening. Korea is still finding several hundred new infection case each day and the country has yet to vaccinate a majority of its people. Employment also remains below the pre-pandemic level.
In a post-decision statement, the central bank said the recovery has strengthened on the back of trade, while consumption is also gradually emerging from its slump. The BOK reiterated its pledge to keep policy accommodative, but said it will pay “closer attention to the build-up of financial imbalances,” including ballooning household debt.
“It’s reasonable to think the new forecast brings forward the timing for policy normalization,” said Cho Yong-gu, a fixed-income strategist at Shinyoung Securities, who sees the bank hiking in the first half of next year. “That’s if jobs return to normal, vaccinations move forward as planned and inflation rises to where the BOK sees it.”
(Updates with Governor Lee’s comments.)
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