The Bank of Korea (BOK) has decided to keep the base rate unchanged at 3.5 percent for the fourth consecutive time, citing a significant cooling down of inflation. The six-member monetary policy board unanimously voted for the rate freeze, with BOK Governor Rhee Chang-yong stating that the terminal rate will also remain at 3.75 percent.
The decision to keep rates steady was driven by signs of easing inflation, as consumer prices growth fell to 2.7 percent last month, dropping below the 3 percent level for the first time in 21 months. Core inflation, which excludes volatile food and energy prices, also experienced a 0.4 percentage point decline from the previous month, coming in at 3.5 percent.
However, despite these positive indicators, inflationary concerns still persist. The recent decrease in inflation can be attributed to the base effect from last year’s price spikes in international oil prices, rather than successful efforts by policymakers to control rising prices. The BOK anticipates that the consumer price index will rebound once the base effect wears off.
Similar trends can be observed in the United States, where the consumer price index fell to 3.1 percent in June, while core inflation rose by 4.8 percent. Governor Rhee highlighted the potential for inflation to rebound in the US as well, citing the base effect as a contributing factor.
In addition to inflationary concerns, increases in public utility charges, such as electricity and gas, as well as potential raises in subway and bus fares by the Seoul Metropolitan Government, further compound worries about inflation. Governor Rhee noted that these additional raises may necessitate an adjustment to the inflation projection made earlier this year.
Another factor that could contribute to higher inflation is Korea’s tight labor market. The country’s employment rate reached a record high of 63.5 percent in June, the highest since 1982, while the jobless rate fell to 2.7 percent, the lowest since 1999. While this signals a recovering economy, it also raises the possibility of higher wages, which could, in turn, drive up inflation.
With the rate freeze, the gap between Korea’s base rate and that of the United States remains at 1.75 percentage points. However, as the US Federal Reserve is expected to raise rates by 25 basis points to 5.25-5.5 percent by the end of the month, the gap could widen to 2 percentage points. Furthermore, there is speculation that the Fed may implement a total rate hike of 50 basis points within this year.
Although concerns about an outflow of foreign capital and increased currency volatility arise from the diverging rate differential between Korea and the US, Governor Rhee emphasized that the rate gap is not the sole determinant of capital flow and currency liquidity. The BOK will not simply follow the Fed’s decisions without considering other factors affecting Korea’s financial market.
In terms of the currency market, the Korean won opened at 1,275 won against the US dollar following indications of cooling inflation in the US, down from the previous day’s closing price of 1,288.7 won. Governor Rhee anticipates stability in the currency market and reiterated that the rate gap is not the sole concern for the BOK.
In conclusion, the BOK has maintained the base rate at 3.5 percent for the fourth consecutive time, citing signs of cooling inflation. While concerns about inflation persist, the central bank believes that the recent decrease in inflation is primarily due to the base effect and projects a rebound in the coming months. The decision to hold rates steady also takes into consideration potential raises in public utility charges and the tight labor market, which could contribute to higher inflation. The rate gap between Korea and the US remains a concern but is not the sole determinant of capital flow and currency stability, according to Governor Rhee. The BOK will continue to evaluate various factors impacting the financial market and take a balanced approach in its decision-making process.
