Fed unveils small rate hike but signals inflation fight not over

Gopinath says labor, pension reform drives step in right direction

WASHINGTON (AFP) — The U.S. Federal Reserve slowed its pace of interest rate hikes Wednesday, tempering an aggressive campaign to rein in costs as inflation cools, but signaled the battle is not yet over.

The U.S. central bank announced a quarter-point hike to the benchmark lending rate at the end of its two-day policy meeting, taking the rate to a target range of 4.50 percent to 4.75 percent.

“Inflation has eased somewhat but remains elevated,” the Fed’s policy-setting Federal Open Market Committee (FOMC) said in a statement.

While recent developments are encouraging, officials will need “substantially more evidence” to be confident that inflation is on a sustained downward path, Fed Chair Jerome Powell told a press briefing.

The FOMC said in the statement that “it anticipates that ongoing increases in the target range will be appropriate” to bring inflation back to policymakers’ 2 percent target.

The Fed has cranked up interest rates eight times since March 2022, including four consecutive 0.75 percentage point increases, lifting borrowing costs in hopes of dampening demand.

The aim is to rein in inflation, which surged last year to its fastest pace in decades but has since come off a peak.

On Wednesday, the Fed acknowledged recent indicators “point to modest growth in spending and production” as economic activity eases.

The 0.25 percentage point rise marks a step down from December’s half-point hike and the series of bigger spikes last year.

But the FOMC statement suggests rate increases will continue.

Powell noted Wednesday that it will take a few more rate hikes to get to an “appropriately restrictive” policy level while inflation runs hot.

And under current expectations, it “will not be appropriate to cut rates this year,” he said.

The Fed also stressed that officials are “highly attentive to inflation risks” amid fallout from Russia’s war against Ukraine, which is contributing to greater global uncertainty.

“I think reforms of this kind will be very beneficial as they can improve the flexibility of the labor market, allow easier entry into product markets and make education systems more consistent with the jobs of today.”

A high-ranking official from the International Monetary Fund (IMF) says that the likelihood of a recession in the Korean economy this year is slim, as China’s COVID-19 reopening will provide the impetus for growth.

In an interview with The Korea Times in Seoul, Tuesday, IMF Deputy Managing Director Gita Gopinath forecast that the Korean economy will continue to stay in the doldrums in the first half before bouncing back in the second half in line with a recovery of the Chinese economy.

“We have growth slowing down, but we have no recession in our baseline for Korea,” Gopinath said.

Citing China’s reopening after years of COVID lockdown, she sided with the Korean government’s prediction that the nation’s economy will start gaining growth momentum in the second half.

“That is consistent with our view that the weakness in the last quarter of 2022 will carry over into the first half of this year, especially because of the effects of the monetary policy tightening which takes some time to work through the system,” she said. “But in the second half, we expect to see a recovery in growth and then into 2024 … because of positive spillovers from China’s recovery.”

The Korean economy is forecast to grow by 2.6 percent in 2024.

Gopinath’s comment comes after the IMF, in its updated world economic outlook report released Tuesday, downgraded the 2023 growth outlook for Korea to 1.7 percent from 2 percent projected back in October.

Prior to the IMF’s forecast, the Organisation for Economic Co-operation and Development (OECD) lowered its growth forecast for Korea to 1.8 percent from 2.2 percent, while the Asian Development Bank (ADB) revised the outlook to 1.5 percent from 2.3 percent.

The IMF report added to the especially murky economic look for Asia’s fourth-largest economy. Its forecasts for the world and multiple individual countries, in contrast, have been upgraded.

The report even prompted a response from the presidential office, which recognized the IMF report “as very authoritative,” but still noted that “there should be some time differences (with the Korean government) when it comes to economic outlooks for certain individual countries.”

Under the circumstances, Gopinath explained that the downgraded outlook for Korea was “a reflection of tightening global financial conditions and tightening domestic financial conditions.”

In particular, she said that weakened growth momentum from a contraction in the last quarter of 2022 is being reflected in 2023.

The Korean economy contracted 0.4 percent in the final three months of last year — for the first time in 10 quarters — as its two main drivers — private spending and exports — jointly declined amid the global economic slowdown.

Asked about major risks that fiscal and monetary policymakers should pay attention to, Gopinath pointed to the prolonged war in Ukraine, high inflation and interest rates, a sluggish housing market and a decoupling of global supply chains.

She assessed the Korean government as “doing the right thing” by pairing fiscal tightening and monetary tightening “so that both of them work in the direction of bringing down inflation.”

“The government has been broadly doing what is broadly consistent with what we would recommend,” she said.

Gopinath viewed President Yoon Suk Yeol’s push for three major reforms of labor, education and pension as critical in coping with an aging society and declining population.

The IMF estimates Korea’s medium-term growth at just over 2 percent. According to Gopinath, structural reform in these three areas can “ensure that the fiscal situation is sound.”

“I think reforms of this kind will be very beneficial as they can improve the flexibility of the labor market, allow easier entry into product markets and make education systems more consistent with the jobs of today,” she said.

As possible solutions to embrace demographic change, Gopinath suggested bringing more women into the workforce, adopting more work-life balance, allowing greater flexibility for women, especially when they want to return after leaving the workforce due to childcare, and adopting more performance-based wage systems instead of time duration-based systems.