Bank of Korea Raises Base Rate by 0.25%p Amid Inflation and Growth

The Monetary Policy Committee of the Bank of Korea (BOK) raised the base rate by 0.25 percentage points (p) from 2.50% to 2.75% per annum today (the 16th) to ensure price stability.

This marks the first monetary tightening decision in three years and six months since January 2023, when the rate was adjusted from 3.25% to 3.50%.

Previously, the committee had focused on economic stimulus by cutting the base rate by a total of 1.00%p across four instances in October and November 2024, and February and May of last year.

In particular, last year, monetary easing was inevitable due to overlapping adverse factors, including political uncertainty following the emergency martial law declaration, a downturn in the domestic construction industry, and the shock of U.S. reciprocal tariffs.

Since then, as household debt continued to rise and the won-dollar exchange rate remained high, the committee had kept the base rate frozen for eight consecutive meetings to monitor internal and external variables.

The committee's shift toward tightening after 14 months of rate freezes is analyzed to be a result of rising inflation concerns coupled with a clear rebound in the economy.

Inflationary pressure has intensified due to the prolonged Middle East war, which began with U.S. and Israeli airstrikes on Iran at the end of February this year.

The Strait of Hormuz, a bottleneck for crude oil supply, was blocked, causing international oil prices (based on Brent crude) to soar from around $72 per barrel just before the war to $126 by the end of April.

Consequently, the consumer price inflation rate gradually rose from 2.0% in January–February of this year to 2.2% in March and 2.6% in April, before recording 3% levels for two consecutive months in May (3.1%) and June (3.2%).

The living necessities price index, which reflects the level of inflation felt by the public, also continued to rise from 1.8% in February to 2.3% in March, 2.9% in April, 3.3% in May, and 3.4% in June.

The BOK is concerned about the secondary ripple effects of rising oil prices, which could increase the costs of not only energy but also other goods in the medium to long term.

On the other hand, real gross domestic product (GDP) growth for this year is expected to improve significantly compared to last year (1.0%) due to strong semiconductor exports.

The real GDP growth rate for the first quarter of this year reached 1.8%, the highest in five years and six months since the third quarter of 2020 (2.3%).

In nominal terms, the economy grew by 10.5%, the highest in 50 years since the first quarter of 1976 (13.0%).

Financial markets analyze that the annual current account surplus this year will likely far exceed last year's record high of $123.05 billion.

In response, the government presented an economic growth forecast of 3.0% for this year on the 14th.

This is 0.4%p higher than the BOK's May forecast of 2.6%, and it is considered certain that the BOK will also upwardly adjust its forecast in August.

The prevailing view is that the robust economic growth, which significantly exceeds the potential growth rate of around 1.8% estimated by the BOK, will not be short-lived.

This implies that the situation is far from one where the base rate must be kept relatively low to support the economy.

Household debt and housing prices are also cited as key considerations.

At the end of last month, the balance of household loans in the banking sector increased by 7.6 trillion won from the previous month, marking the largest increase in one year and 10 months since August 2024.

It appears that the surge in housing transactions, which spiked ahead of the end of the grace period for heavy taxation on capital gains for multi-home owners (May 9), has led to an increase in household loans with a time lag.

Seoul apartment prices have shown a high upward trend of 10–15% on an annualized basis recently, driven by concerns over supply shortages and expectations of further price increases.

Voices calling for monetary tightening to raise borrowing thresholds and curb rapidly rising house prices have grown louder.

The won-dollar exchange rate, which reached the 1,560 won range early last month, has recently fallen to the 1,480 won range due to expectations of won conversion of funds raised through SK Hynix's U.S. American Depositary Receipts (ADR), but it remains at a level higher than the long-term average.

With this base rate hike, the gap between the policy rates of South Korea and the U.S. (3.50–3.75% per annum) will narrow from 1.25%p to 1.00%p.

This is the smallest gap in three years and four months since the difference widened from 1.25%p in February 2023 to 1.50%p in March 2023, and the BOK's recent stance is that narrowing the Korea-U.S. interest rate gap can help restore the fundamental value of the won.

BOK Governor Shin Hyun-song has repeatedly stated an unusually clear position since May, saying, "It is judged that there is a need to raise the base rate at an appropriate time."

The dot plot reflecting the committee members' base rate forecasts for six months after May 28 also shows that 19 out of 21 total dots are placed at points higher than 2.50% per annum.

This is also in line with the trend of major central banks, such as the European Central Bank (June 11) and the Bank of Japan (June 16), successively raising their base rates.

Accordingly, the market believes there is a possibility that the committee may raise the base rate by an additional 0.25%p in August or October of this year.

This suggests an expectation of entering a full-scale interest rate hike cycle.

Governor Shin will personally explain the background of the base rate decision and the future direction of monetary policy at a press conference at 11:10 a.m. today.

(Photo: Yonhap News)
※ Please note: This article was translated by AI and may contain errors.