Rate hike, high inflation throw BOK into dilemma

Record increase in utility service costs pushes inflation upward again

The Bank of Korea (BOK) is facing a dilemma over whether it should keep increasing its policy rate, as the U.S. Federal Reserve is poised to deliver additional rate hikes following a 25-basis-point hike, Thursday (KST).

The Fed’s quarter-percentage-point increment puts the U.S. base rate in a range between 4.50 percent and 4.75 percent, as compared to Korea’s 3.5 percent, and widens the interest rate gap between the two countries by up to 1.25 percentage points.

The Fed is slowing the pace of its hikes following a series of steep 75and 50-basis-point rate increases in 2022.

Still, even a conventional 25-basispoint hike in the Fed’s next rate-setting meeting will raise the U.S. key interest rate to a range between 4.75 percent and 5 percent and widen the U.S-Korea interest gap to up to 1.5 percentage points if the BOK freezes its own rate at the current level.

The two countries’ next rate-setting meetings are scheduled for Feb. 23 in Korea and March 15 and 16 in the U.S.

The possible 1.5 percentage point gap will be the highest since 2000. Accordingly, such a gap can flare up concerns over outflow of foreign capital as witnessed in the past.

“I’d say the focus of the Fed’s rate policy is shifting to the extent of rate increases from the pace of increases, which will give the BOK room to breathe in its rate policy after it was in a rush last year to narrow down the interest gap with the U.S.,” Hana Securities analyst Chun Kyu-yeon said.

Nevertheless, Chun referred to Fed Chair Jerome Powell’s remark that rate cuts are not in the offing, with regard to U.S. inflation that closed out at 6.5 percent in 2022. U.S. inflation last year was far above the Fed’s 2 percent target.

“Under the circumstances, the BOK is likely to be wary of the U.S.-Korea interest gap considering the Fed is projected to raise the rate as high as 5.1 percent,” Chun said.

He also cited the minutes released by the BOK monetary policy board after its Jan. 13 rate-setting meeting, in which the base rate was hiked 25 basis points to the current 3.5 percent.

A board member expressed concerns over investor sentiment in the currency market, in case the U.S.-Korea interest gap keeps widening, and suggested sticking to a policy of incremental rate increases.

BOK Governor Rhee Chang-yong has been addressing the need for a trade-off between inflation and growth, as inflation has been cooling down in recent months.

Speaking on condition of anonymity, an economist at a private think tank forecast that accelerated inflation in January can pose a challenge to such a plan for a trade-off.

Statistics Korea announced on Thursday that inflation grew 5.2 percent in January from a year earlier.

January inflation marked a threemonth high after consumer prices grew at 5.7 percent in October and decelerated to 5 percent in both November and December.

Inflation in the 5 percent range is well above the BOK’s target inflation of 2 percent.

Increases in consumer prices last month were due mainly to the record 28.3 percent year-on-year increase in prices of utility services. It was the sharpest growth since the relevant data began being measured in 2010.

Utility costs soared in the midst of a global energy crisis, coupled with a hike in electricity prices beginning in January.

A cold wave pushed prices upward for agricultural, fisheries and livestock products to 1.1 percent yearon-year, as compared to a 0.3 percent increase in December.