Final Monetary Policy Board Meeting of the Year: Clock Ticking on Forecasts... Growth and Inflation Offer Clues [BOK Focus]

BOK Monetary Policy Board to Make Its Final Rate Decision of the Year on the 26th
This Year's Growth Forecast Expected to Be Raised to Around 3.8%
Expected U.S. Rate Hike at Year-End Also Raises Odds of a November Hike in Korea
Inflation: If Core Inflation Does Not Cool Enough This Month, Case for a Rate Hike Strengthens
FVI Trend Also in Focus... Markets See Terminal Rate at 3.50%

The Bank of Korea's Monetary Policy Board will meet on the 26th of this month to decide on the policy rate for the final time this year. Attention is focused on the Bank of Korea's detailed forecasts for economic conditions, including growth and inflation, this year and next, and on whether it will raise rates again. Based on figures available through the third quarter, markets have raised their expectations for this year's economic growth rate to around 3.8%. The Bank of Korea remains concerned that core inflation is not easily falling toward the target level, adding weight to forecasts of a rate hike in November.

Taking into account confidence in the economic upswing led by semiconductor exports, the possibility of a higher neutral interest rate, expected growth in consumption as income conditions improve, and still-elevated inflation expectations, markets expect the terminal rate in this hiking cycle to rise to 3.50% or higher. However, some say that the risks of unsustainable fiscal spending and the possibility that stock market corrections could have a greater impact on the real economy should be monitored.

Shin Hyun-song, governor of the Bank of Korea, speaks at a press conference after a meeting of the Monetary Policy Board at the Bank of Korea in Jung-gu, Seoul, on the 22nd of last month.

Third-Quarter GDP Data In: Growth of Around 3.8% Expected This Year

Since the Monetary Policy Board held rates steady last month, several major events have taken place, including the release of preliminary third-quarter real gross domestic product (GDP) figures for South Korea and policy rate decisions by major economies such as the United States. Based on developments so far, markets believe Bank of Korea Governor Shin Hyun-song is likely to play the "hawk" card (a preemptive rate hike) again this month.

Growth is the main reason. The expected upward revisions to growth forecasts for this year and next, flagged at last month's Monetary Policy Board meeting, have raised expectations further following the release of third-quarter results. As of November 1, the average forecast for South Korea's GDP growth this year from eight major domestic and international financial and investment firms - Samsung Securities, Shinhan Securities, Daishin Securities, Hanwha Investment & Securities, Meritz Securities, iM Securities, Hyundai Motor Securities, and Citibank - stood at 3.76%. Five of the eight expect growth of 3.8%.

Semiconductors are once again underpinning these expectations. "From the fourth quarter of this year through the second quarter of next year, solid real GDP growth of 0.8-1.0% quarter on quarter is expected to continue, driven by an extended memory semiconductor upcycle and spillover effects into domestic demand," said Kim Jin-wook, chief economist at Citibank. "At this month's Monetary Policy Board meeting, the Bank of Korea is expected to raise its growth forecasts for this year and next to around 3.8% and 3.3%, respectively." He added, "We are also raising our forecast for nominal GDP growth this year to 26.7%, the highest level since 1978. Given Governor Shin's recent emphasis on a data-dependent approach, the strong third-quarter GDP reading will further reinforce the Bank of Korea's monetary tightening stance."

Jeong Seong-tae, an economist at Samsung Securities, also expects global investment in artificial intelligence (AI) infrastructure to continue driving South Korea's exports and capital investment. "Starting at the end of next year, expanded capital investment will also begin to boost semiconductor production in earnest," he said. "With government fiscal spending set to increase by 12.8% next year, supported by higher tax revenue, growth is expected to reach 3.9% this year and 3.3% next year."

At the end of last month, the upper bound of the U.S. policy rate remained at 4.00%, but market expectations of a rate hike by year-end remain high. Major U.S. investment banks agreed that Fed Governor Kevin Warsh's somewhat lukewarm remarks about U.S. inflation last month had heightened doubts about the Fed's commitment to price stability. However, based on wording used in the statement's assessment of the economy, they believe the bias toward further rate hikes remains in place. If the Fed raises rates at year-end, South Korea's sensitivity to Fed policy could rise again. Some analysts also say that maintaining the Korea-U.S. interest rate gap at its current level of 1.00 percentage point could be cited as grounds for a hike this month.

Kevin Warsh, chair of the U.S. Federal Reserve. Photo by AP-Yonhap News.

Bank of Korea Concerned About Demand-Side Inflation Pressures... Terminal Rate Seen at 3.50%

The Bank of Korea remains concerned about inflation. It has warned that next year's consumer price and core inflation rates will exceed its previous forecasts of 2.3% and 2.5%, respectively, as elevated cost pressures continue to pass through and demand-side pressures gradually increase. Governor Shin has stressed, "We will continue to respond until we are confident that inflation is converging steadily toward the Bank of Korea's target level of 2.0%." Accordingly, markets expect another hike around February next year, following a rate increase this month. The prevailing forecast is for the terminal rate to reach 3.50%.

"On inflation, attention should be paid to changes in the outlook for next year rather than the recent short-term slowdown," said Kim Myeong-sil, a researcher at iM Securities. "The key going forward will be whether cost shocks, including those related to energy, spread to service prices, and whether improved incomes support price increases through wages and consumption." The case for further hikes will strengthen if the data available through this month do not show a sufficient slowdown in core and services inflation.

"The Bank of Korea still appears wary of the spillover effects of exports on domestic demand and of demand-side inflationary pressures," said Cho Yong-gu, a researcher at Shinyoung Securities. "Given its emphasis on the possibility of a higher neutral interest rate, its commitment to addressing inflation, and the need to maintain a restrictive stance, the likelihood of an additional hike in November is high." However, he said the final hike is likely to come later than the preemptive moves made early in the cycle, and placed more weight on a hike in April than in February next year.

Analysts say the accumulation of financial imbalances is also strengthening the case for further rate hikes. They say the need for monetary tightening is supported by the continued expansion of medium- to long-term financial imbalances, amid expectations of rising home prices in the Seoul metropolitan area and the possibility of increased leverage as asset prices rise. "The Financial Vulnerability Index (FVI), which Governor Shin has highlighted, rose for the ninth consecutive quarter through the second quarter, reaching 46.5, and is above its long-term average of 45.7 since 2008. This makes its future trajectory worth watching," said Min Hyeon-ha, a researcher at Hana Institute of Finance.

However, it is important to monitor how financial soundness is diverging across sectors: prolonged high interest rates are increasing debt repayment burdens for vulnerable borrowers, while corporate delinquency rates are also rising, particularly for non-bank lenders and small and medium-sized enterprises. Whether the recovery in private consumption broadens is also seen as an issue to watch amid the rate-hiking cycle. "Bonuses and dividend payments in booming industries are factors that can directly stimulate household consumption, while increased government spending from higher corporate and income tax revenues will also help spread private consumption through redistribution across income groups," said Kim Jin-seong, a researcher at Heungkuk Securities. However, he cautioned, "Income disparities are likely to widen, and differences in propensity to consume mean that the boost to consumption may be limited relative to the increase in aggregate income." He added that redistribution through the government's income redistribution function can take time and may have a diminished effect. 

This content was produced with the assistance of AI translation services.