BOK likely to freeze base rate after 18 months of hikes

With the Bank of Korea set to hold its rate-setting meeting on Thursday, the market is expecting a freeze to the base interest rate for the first time in a year and half, marking an end to its rate hike cycle.

The central bank, with its base rate standing at 3.5 percent, has been leading an aggressive monetary tightening policy, continuously raising the key rate since August 2021 to tamp down soaring prices.

The market, however, expects the central bank to take a pause this month, considering the slowing economy.

Korea's economy contracted 0.4 percent in the fourth quarter of 2022 compared to the previous three months, falling into the minus range for the first time since the second quarter of 2020.

"The growth rate for this year was projected to be at around 1.7 percent in November, but there is a strong possibility it could fall lower," BOK Gov. Rhee Chang-yong said at a press conference held after a rate-setting meeting in January.

"The first half of this year will be a difficult period with low exports and a global economic slowdown,” Rhee said.

Despite economic indices signaling an economic downturn, the ongoing inflation is yet to be tamed, challenging the central bank with its priority on price stabilization.

The consumer price index, a major barometer of inflation, is still in the 5 percent range after peaking at 6.3 percent in July. Though the BOK assessed that inflation has passed its peak, it is yet to be fully resolved, still high above the 2 percent target range set by the central bank.

The US Federal Reserve has also yet to end its aggressive monetary tightening. Though it has slowed down on its interest rate hike pace, it is likely to continue to raise the base rate.

The US base interest rate climbed to 4.5-4.75 percent per annum as the Fed raised the key rate by 0.25 percentage points on Feb. 1, widening the gap between Korea's key rate and that of the US.

At a press event held after the decision, Fed Chair Jerome Powell said he foresees “a couple more rate hikes,” which will eventually widen the key rate differential even further.

If the Bank of Korea freezes the rate, the gap will reach 1.75 percentage points, breaking the previous 1.5 percentage point record set in 2000, possibly leading to concerns of a foreign capital outflow and the fall of the Korean currency against the dollar.

With the Fed hinting at future rate hikes, the Korean currency has weakened, hitting 1,300 won for the first time in two months on Friday. The currency closed at 1294.5 won on Monday.

Nevertheless, the market remains hopeful, projecting a rate freeze decision to come this week.

NH Investment & Securities analyst Kang Seung-won expects a rate freeze for the time being.

“Rhee is likely to stress data dependence, opening room for a further rate hike, in concern that the rate freeze could be met with an overly dovish interpretation from the market,” Kang said.

Though the central bank is likely to freeze the rate at 3.5 percent this week, there still remains the possibility of further rate hikes within the year, market experts viewed.

“Rhee and other members of the Monetary Policy Committee viewed 3.5 percent to be of a restrictive level in the previous meeting,” said Min Ji-hee, an analyst at Mirae Asset Securities, agreeing to the projection that the central bank will freeze the rate in the upcoming meeting.

However, there is a possibility of a further rate hike within the year, Min said.

“With the consumer price index surpassing the 2 percent target range, the possible rebound of China's economy and expectations growing on the soft landing of the US economy can lead to a better outlook for Korea's export. These could be factors for the central bank to maintain its rate hike stance for the long term,” Min said.