BOK chief says policy direction is clear as bank raises growth forecast to 2.6%

Korea's central bank sharply raised its economic growth forecast for this year on Thursday, in a move that aligns with its signal of further interest rate hikes ahead. Its monetary policy board, however, kept the benchmark rate unchanged at 2.5 percent during a meeting as it waits for clearer signs of how uncertainty from the war in the Middle East and its spillover effects will filter through the economy.

The Bank of Korea (BOK) lifted the country's growth outlook to 2.6 percent from the 2 percent projected in February on robust semiconductor exports despite uncertainty stemming from the war in the Middle East. It was the sharpest upward revision since May 2021.

In the first monetary policy board meeting since the inauguration of new BOK Gov. Shin Hyun-song last month, markets focused closely on the future direction of monetary policy and the governor’s tone.

"Stronger-than-expected demand for semiconductors and expanding information technology exports are expected to lift economic growth by 0.7 percentage points this year, while the government’s supplementary budget and a buoyant stock market are projected to add 0.2 percentage points and 0.1 percentage point, respectively," Shin said during a press conference held in central Seoul following the board meeting. He added that the war in the Middle East would shave 0.4 percentage points off this year’s growth rate.

The BOK’s growth forecast exceeds the 2.4 percent average projection of eight global investment banks as of late April, including JPMorgan and Goldman Sachs.

“Given current price trends, prices are likely to remain elevated and semiconductors are not a product that can be ramped up quickly in the short term. As a result, some view this as a relatively long-lasting effect,” Shin said. “In that sense, the upward revision to growth appears to reflect not a temporary, one-off development, but a trend likely to persist for an extended period.”

The central banker also stressed the need to raise interest rates.

“It is seen necessary to raise the benchmark interest rate at an appropriate time in the future,” he said, adding that the timing and pace of any increase would be determined based on incoming data, as policymakers assess the extent of upward pressure on inflation, the trajectory of the economic recovery and financial stability conditions.

“The most difficult aspect of monetary policy is a dilemma in which policy objectives conflict and the direction is unclear, but it’s exceptional this time,” he said. “Whether viewed through inflation, growth, the exchange rate or the property market, the path forward is clear,” Shin noted, signaling monetary tightening as the won remains weak against the dollar and the property market remains hot.

In the Thursday meeting, two monetary policy board members — Ryoo Sang-dai and Chang Yong-sung — already dissented in favor of a quarter percentage point rate increase to 2.75 percent.

The BOK revised up its inflation forecast for this year to 2.7 percent from the previous 2.2 percent projected in February, as the war in the Middle East is expected to keep oil prices elevated for some time.

“Even if a cease-fire were reached immediately, oil production cannot be turned on and off like a tap,” Shin said, noting that it is technically difficult to ramp up output and that restarting production would take considerable time. The BOK’s baseline assumption is that roughly 60 percent of last year’s volume will continue to pass through the Strait of Hormuz through the end of the year.

Below are the edited excerpts from the press conference.

Q. There has been talk of several rate hikes this year. How was that discussed at this meeting?

A. Inflation and growth were assessed alongside financial conditions, including the exchange rate, household debt and housing prices.

On inflation, Middle East tensions pushed up oil prices, which directly affected consumer prices. Oil also functions as an intermediate input, transmitting through value chains into goods and services prices. The most important channel is second-round effects, through which higher prices feed into inflation expectations and core inflation, influencing firms’ pricing behavior as well as wages and demand. While core inflation in April stood at 2.2 percent, other indicators suggested underlying inflationary pressure.

On growth, stronger-than-expected first quarter data led to an upward revision of the full-year growth forecast to 2.6 percent, reflecting the view that the momentum would continue. If Middle East tensions are resolved quickly, growth could exceed that forecast, underscoring the economy’s resilience.

On financial conditions, the won has weakened, while concerns over housing prices and household debt are re-emerging. In policymaking, the most difficult situation arises when multiple objectives conflict, creating a dilemma in which the direction is unclear. This time, however, the path is relatively clear whether viewed through inflation, growth, housing or the exchange rate, and the benchmark rate will be managed in a consistent manner going forward.

What’s driving the recent weakness in the won? Before taking office, you said the non-deliverable forward (NDF) market was one of the factors behind the won’s depreciation. How do you plan to address that?

The main factor behind the weakening of the currency is the Middle East conflict. On a day-to-day basis, developments in the region tend to fuel risk aversion and market volatility. This is not unique to Korea; it is a common pattern among oil-importing countries. The yen and the rupee, for example, are also affected. In that sense, it is somewhat encouraging that if the situation in the Middle East improves, there is room for the won to strengthen going forward.

An NDF is settled in dollars. In a typical swap market, principal in won and dollars is exchanged and then returned at maturity. An NDF, by contrast, allows offshore settlement in dollars for the difference in value without access to physical won. Because of this structure, it is a market where transparency is lower than in onshore markets governed by domestic regulation.

As a result, the NDF market can create situations in which the tail wags the dog, with price movements occurring during overseas trading hours — at night in Korea. Those trades can spill over into the domestic market, as it prompts hedging activity and sometimes feeds back into onshore trading.

The way to address this is to promote the internationalization of the won and bring such activity into the institutional framework. That would mean ensuring that, in swap transactions involving the won and the dollar, actual won funding is secured and principal is physically exchanged and returned at maturity.

Also, I want to make clear that there will be a firm response to any one-sided movements on the exchange rate. Such herdlike movements in the currency will not be tolerated, and the authorities have both the tools and the will to act.

As strong first quarter growth of 1.7 percent was driven by semiconductors, some argue that there is no spillover to other sectors. What do these factors mean for the outlook on monetary policy going forward?

While semiconductors are the primary beneficiary, it is not accurate to say there is no spillover effect. Rising wages and increased investment in semiconductor facilities, including construction activity, have already contributed to a broader improvement in the economy. Capital investment, construction investment and consumption all reflect a general spread of economic momentum.

The fiscal benefit is also important. Strong corporate earnings are expected to significantly increase tax revenues as firms pay more corporate taxes, and this increase in tax revenue ultimately benefits the broader public. In addition, as previously noted in relation to the Samsung Electronics labor agreement, performance-based bonuses generate income tax revenue, meaning the spillover effects are also realized through fiscal channels, likely becoming visible next year.

Overall, it is not correct to say there is no spillover effect. There is demand-side spillover, and importantly, broader benefits flow to the public through the fiscal system. 

BY JIN MIN-JI [[email protected]]