Bank of Korea Governor Hyun Song Shin explained the decision at a press conference held after the rate announcement, saying, "We need to assess how internal and external risk factors unfold, as well as the spillover effects of the two previous rate hikes." It marked the first rate hold in five months since May, and the third hold of the year at a monetary policy direction meeting. All seven board members, including Shin, voted to keep the rate unchanged. No dissenting opinion calling for a hike, which the market had anticipated, was recorded.
Shin stressed that preemptive tightening had bought time to moderate the pace of rate increases. "When we raised rates in August, I said we had used a hoe to stop what would have required a pitchfork. This hold is the fruit of that hoeing," he said. He assessed that the consecutive hikes in July and August had given the central bank room to tailor policy to Korea's economy, and that a stabilized exchange rate had bought time.
On the policy outlook, however, Shin strongly signaled further increases. "Growth and inflation appear likely to run stronger than our August forecasts, so we need to maintain our tightening policy stance," he said. "We will respond until we are confident that inflation is stably reaching our target level of 2%."
The board indeed projected that growth this year and next would considerably exceed its August forecasts of 3.3% and 2.9%, respectively. It also expects inflation of 2.7% this year and a rate above the previous 2.3% forecast next year. With Shin projecting that inflation will reach the central bank's 2% target the year after next, he signaled that the tightening stance will continue at least through the end of next year.
Most market watchers expect two more rate increases through next year. "If the November revised economic outlook officially raises growth and next year's inflation forecasts, the case for additional hikes will strengthen," said Kim Myung-sil, an analyst at iM Securities. "We expect hikes in November this year and in the first quarter of next year."
Others see three more increases through next year. Kim Ji-man, an analyst at Samsung Securities, projected three additional hikes in November, February and May, bringing the terminal rate to 3.75% next year. "The Bank of Korea's signal that it will considerably raise growth forecasts for this year and next, and lift next year's inflation forecast as well, reads as an attempt to offset factors that would impede further hikes, such as falling stock prices," he said. "A strong tightening stance will continue through next year."
On the won, Shin said the currency has stabilized recently but remains weak on an effective exchange rate basis. "The high exchange rate situation in early summer this year had very exceptional and abnormal aspects," he said. "The trend of the won falling quickly and finding stability was a process of unwinding that abnormality." He added, "Predictability matters most when it comes to the exchange rate. On an effective exchange rate basis, the won is still weaker than in previous years."
The effective exchange rate is a currency gauge estimated by the Bank for International Settlements that reflects differences in trading partners' currency values and prices. As of the end of August, the won's effective exchange rate stood at about 89, below its long-term average of 101.
Shin assessed the declining exchange rate positively. "As the exchange rate stabilized lower, import prices fell," he said. "Research shows that when the exchange rate drops 10%, the purchasing power of households in the bottom income quintile rises more than 0.4%, so it is also contributing considerably to easing polarization."
Treasury bond yields were mixed after the rate decision. In the Seoul bond market, the three-year treasury yield rose 1.8 basis points from the previous session to 3.840%, while the 10-year yield fell 0.8 basis point to 4.152%.