South Korea’s central bank kept its base rate at a record low for a sixth straight month Thursday, apparently agonizing over its next rate decisions in the face of the US Federal Reserve’s signaling of faster-than-expected rate hikes next year and the political crisis-hit domestic economy.

The Bank of Korea’s seven members of the monetary policy committee unanimously decided to hold the base rate at 1.25 percent, the bank said.
 

The decision came just hours after the Fed raised its target rate by 25 basis points to a range of 0.5 percent to 0.75 percent citing a modest US economic growth. The Fed’s second rate hike since the 2008 global financial crisis had been widely expected in the market with nearly full employment and rising inflation in the US.

However, with the Fed forecasting three interest rate hikes next year instead of the previously anticipated two, Seoul officials hurriedly set up meetings to prevent any excessive market volatility.

Acting President Hwang Kyo-ahn told ministers to take necessary measures to stabilize the financial markets, as the Fed’s rate hike could drive up market interest rates in Korea.

“If market interest rates go up, the government plans to enhance support for SMEs and vulnerable households who are under heavier burden,” Hwang said in a ministerial meeting in Seoul.

After announcing the BOK’s rate decision, BOK Gov. Lee Ju-yeol said he does not expect the narrowed gap between Korea and the US to result in a massive exodus of foreign capital.

“Korea has ample foreign currency in the private sector, on the back of a current account surplus. Foreign reserves are not in shortage either. It’s not a situation to worry about an excessive exodus of foreign capital,” Lee said at a news conference in Seoul.

However, the bank will keep monitoring how fast the Fed seeks rate hikes next year, which is a major external risk with uncertainty coming from President-elect Donald Trump’s new economic policies, Lee said.

On the domestic front, “downside risks have grown due to worsened consumer sentiment and the political risks,” he said, adding that the BOK is to release its revised 2017 economic outlook in January.

The hawkish stance of the Fed is giving more headache for the BOK, which has been maintaining expansionary monetary policies to sustain the faltering growth.

The BOK could seek a rate hike to prevent a foreign capital exodus but doing so would heavily weigh on vulnerable indebted households who have to pay higher interest rates for their mortgage loans they took out on cheap money.

The all-time high level of household debt, which is estimated to have exceeded 1,300 trillion won ($1.1 trillion) as of October, is threatening especially when the real estate market begins to show signs of an oversupply, observers said.

The state-run think tank Korea Development Institute warned that if household debt continues to grow in the current pace, a 1 percentage point rise in market interest rate with a 5 percent decrease in disposable income would make an average household to pay 14 percent higher principal repayments a year.

Meanwhile, credit rating agency Moody’s said in a report that “steeper-than-expected US rate rise and higher volatility could negatively affect banks’ foreign currency funding plans or insurers’ acquisitions of overseas assets.”

This year, an expected stronger dollar has led foreign investors to sell off their holdings in Korean bonds. According to financial industry data, the volume of bonds held by foreigners shrank to 89 trillion won as of Tuesday from about 90 trillion won at the end of 2012.

Trump’s presidential election victory on Nov. 8 and the following forecast for a stronger greenback accelerated the exodus of foreign capital in Korea, pushing up the dollar against the won further. 

Lee said now is not the time to use the government’s bond stabilizing fund, which is prepared as “a contingency plan.”

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