The Bank of Korea held its benchmark interest rate at 3% at a monetary policy board meeting on the 22nd, pausing after two unusually consecutive increases in July and August. The central bank made clear that its tightening stance remains in place, saying both growth and inflation are likely to run stronger than it had forecast.
Governor Shin Hyun-song said at a press conference after the decision that the bank needed "to assess how domestic and external risk factors unfold and the spillover effects of the two previous rate increases." It was the first hold in five months since May, and the third at a rate-setting meeting. All seven board members, including Shin, backed the decision. No dissenting vote for a hike emerged, contrary to market expectations.
Shin said the pre-emptive tightening had bought time to moderate the pace of further increases. "At the time of the August hike, I said we had used a hoe to stop what would otherwise have required a plow. This hold is the fruit of that hoeing," he said. He added that the back-to-back increases in July and August gave the bank room to tailor policy to the domestic economy, and that a steadier won had also bought time.
Still, Shin signaled firmly that tightening would continue. "Growth and price increases appear likely to be stronger than our August forecast, so we need to maintain a tightening policy stance," he said. "We will respond until we are confident that inflation is settling stably at the target level of 2%."
The board indeed projected that growth this year and next would exceed its August forecasts of 3.3% and 2.9% by a considerable margin. It expects inflation of 2.7% this year and a rate above the earlier 2.3% projection for next year. With Shin putting the arrival at the bank's 2% target in the year after next, the message was that tightening will continue at least through the end of next year.
Market watchers expect two to three more increases through next year. Kim Myung-sil, an analyst at iM Securities, said the case for further hikes would strengthen "if the growth and next-year inflation forecasts are officially revised upward in the November economic outlook," adding that she expects increases in November and in the first quarter of next year. Kim Ji-man, an analyst at Samsung Securities (016360.KS), forecast three more hikes — in November and in February and May of next year — bringing the terminal rate to 3.75% next year.
On the currency, Shin said the won had stabilized recently but remained weak in effective exchange rate terms. "The rapid decline and stabilization of the exchange rate was a process of unwinding an abnormal situation," he said. "But measured by the effective exchange rate, the won is still weaker than in previous years."
The effective exchange rate is a currency gauge estimated by the Bank for International Settlements (BIS) that reflects differences in the currency values and prices of trading partners. The won's effective rate stood at about 89 as of the end of August, below its long-run average of 101.
Shin assessed the currency's decline positively. "As the exchange rate has stabilized lower, import prices have come down," he said. "Research shows that a 10% drop in the exchange rate raises the purchasing power of households in the bottom income quintile by more than 0.4%, so it is also proving quite beneficial in easing polarization."
