BOK faces close call on back-to-back rate hike

The Bank of Korea is set to hold its next rate-setting meeting Thursday, with markets split over whether the central bank will deliver another rate hike or pause, a decision that could offer clues on the pace and extent of its current tightening cycle.

The BOK raised its benchmark rate by 0.25 percentage point to 2.75 percent in July, marking its first rate hike in over three years since January 2023. Markets are now watching whether the central bank will deliver a back-to-back rate hike.

Following the July policy meeting, BOK Gov. Shin Hyun-song said second-quarter gross domestic product growth and July consumer inflation would be key factors in determining the pace and extent of further monetary tightening.

Both indicators have since pointed to stronger-than-expected economic conditions, potentially adding to the case for further tightening.

Real GDP grew 0.6 percent in the second quarter from the previous quarter, three times faster than the BOK’s 0.2 percent forecast. If the current trend continues, the economy is on track to grow by around 3 percent for the full year.

Consumer inflation fell back to the 2 percent range last month for the first time in three months, but core inflation, which excludes volatile items, rose 2.6 percent, marking its fastest increase in over two years.

With Shin having repeatedly stressed in public remarks that he places greater weight on core inflation, the BOK is expected to pay closer attention to the underlying inflation trend in its rate decision.

An additional rate hike would signal that the BOK is taking a preemptive approach to containing inflation and maintaining financial stability. It would also mean Korea is moving to tighten monetary policy ahead of the US Federal Reserve, which has kept its policy rate unchanged for five consecutive meetings through last month.

“The August decision is important because it will determine whether the current rate-hike cycle is characterized by a preemptive or cautious approach,” Kang Seung-won, an analyst at NH Investment & Securities, said.

“There is little to be gained from waiting until October, while the costs of delaying a rate hike are growing,” Kim Myung-sil, an analyst at iM Securities, said.

Meanwhile, those projecting a rate hold argue that the BOK could take more time to assess the impact of last month’s rate hike, pointing to a slowdown in inflation in July, strengthening of the Korean won and the recent correction in the stock market.

“There is no need to take unnecessary risks. A message keeping the possibility of another rate hike open could itself deliver a degree of tightening,” Kim Ji-na, an analyst at Eugene Investment & Securities, said.

Apart from the rate hike, eyes are also on how high the BOK will ultimately raise its base rate. Markets are currently pricing in the possibility of one more rate hike this year, which would bring the base rate to 3 percent by the end of the year.

“However, if oil prices rise and the value of the won per dollar weakens simultaneously, while core inflation picks up again or household lending and housing prices in the Seoul metropolitan area rebound rapidly, the possibility of an upward revision to the projected terminal rate cannot be ruled out,” Ahn Ye-ha, an analyst from Kiwoom Securities said.

During the previous monetary tightening cycle following the COVID-19 pandemic, the benchmark rate peaked at 3.5 percent.