Fed’s rate hike soothes market concerns, raises fundamental economic risks

The US Federal Reserve’s rate hike Thursday and its message on two additional hikes within this year has soothed concerns in the South Korean financial market for the time being, the nation’s central bank said.

The Fed’s rate increase, however, also raised concerns over a possible foreign capital flight from Korea to the US by those seeking higher yields on safer assets.

As the Fed’s rate hike makes it harder for the South Korean central bank to move its own rates, it is expected to narrow down Korea’s options to stimulate the economy, which is already burdened by low growth, heavy household debt and record-high unemployment, observers said.

The rate hike in the US is also expected to encourage the rise of market interest rates that could tip over the threatening surge of household debt and further freeze domestic demand.

A stronger dollar would bring immediate advantage to exporters here but could pose long-term risk by weakening the developing markets that 57.5 percent of Korea’s exports depend on. 

The Fed has raised its benchmark short-term interest rate by 0.25 percentage point to a range of 0.75 percent to 1 percent, citing strengthening US jobs and rising inflation. With little change in its view on the US economic outlook, a larger proportion of the 17 Fed officials, nine instead of the previous six, forecast that the bank would raise rates two more times this year.

In response, the Bank of Korea said, “The Fed’s rate hike has met our expectation and its future policy rate moves are in the same trajectory that were previously expected. This has greatly soothed some market players’ concerns over a faster acceleration of rate hikes.

“Following this, South Korea’s foreign exchange stabilization bond yield and credit default swaps premium went down.”

The BOK said it would closely monitor changes in external conditions, such as Washington’s new economic policies, Beijing’s policy toward Seoul and political developments in Europe, to prevent excessive market volatility.

On the news of the US rate hike, the local bourse Kospi hit the 2,150 mark in morning trading, which was the highest level in almost two years, as investor sentiment improved on cleared uncertainty.

Vice Finance Minister Choi Sang-mok said the government will act to stabilize markets when necessary.

The financial regulator separately announced a measure to alleviate the burden on small and medium-sized companies sparked by the Fed’s rate hike.

“We will support policy banks to help SMEs who have difficulties in issuing corporate bonds or acquiring a company due to higher borrowing costs. We will proceed with a 2.2 trillion won ($1.94 billion) worth support plan for corporate bonds and acquisition finance,” said Jeong Eun-bo, vice chairman of the Financial Services Commission at a joint meeting with the Financial Supervisory Services to check financial risks in response to the US rate hike.

Experts say the BOK now has little room to move its base rate in any direction this year, due to mounting household debt and the already all-time-low interest rate.

The nation’s household debt reached 1.34 quadrillion won as the end of 2016, or about 83 percent of gross domestic product, according to the Bank of Korea’s latest data. This weighs on vulnerable households who will have to pay higher interest rates on their loans.

“Korea is already spoiled by low interest rates. With such large household debt, with a majority of it taken under floating rates instead of fixed ones, the BOK cannot raise the rate this year,” said Oh Suk-tae, an economist at Societe Generale.

“With economists recently revising down Korea’s growth outlooks, the BOK would lower the rate to support growth. But the current 1.25 percent base rate is already very low. So the bank will just stay still until this year.”

At the latest monetary policy committee’s meeting in February, the BOK kept its base rate at a record low of 1.25 percent, an eighth consecutive rate freeze since lowering it by 0.25 percentage point in June last year.

With the Fed’s rate hike, the interest rate gap between the US and Korea narrowed from the previous 0.5-0.75 percentage point to 0.25-0.5 percentage point.

Hana Financial Investment analyst Lee Mi-seon noted that the US-Korea interest rate gap could be reversed on a scenario that the US raises rates further in June and December.

Jang Byung-hwa, deputy governor of the BOK, told reporters that a US rate hike does not mean the the BOK should automatically follow suit, echoing BOK Gov. Lee Ju-yeol’s previous remarks on the interest rate gap.

The central bank is scheduled to hold the next rate-setting meeting on April 13.

By Kim Yoon-mi (yoonmi@heraldcorp.com)