By Howard Schneider, Ann Saphir and Cynthia Kim
JACKSON HOLE, Wyo./SEOUL (Reuters) – Bank of Korea Gov. Rhee Chang-yong said Saturday interest rates would need to continue increasing until inflation is in decline, but the country likely could not call a halt to its tightening cycle before the U.S. Federal Reserve.
Dollar appreciation driven by Fed rate increases has added to inflation in many open economies around the world, including Korea, as the local currency falls in value.
“We are now independent from government, but we are not independent from the Fed. So if the Fed continues to increase the interest rate it will have a depreciation pressure for our currency,” Rhee said in an interview with Reuters. Although the Bank of Korea began raising interest rates before the Fed, with its first hike coming a year ago, “whether we can end earlier – I don’t think so.”
Inflation in Korea is largely the result of outside issues like energy prices, Rhee said, and, “if you ask me, whether I’m going to stop … what happens if the oil price increases again? … It’s very hard for us to know the exact timing, given the importance of the external shock.”
Even though he expects domestic inflation to cool in August compared with the 6.3% rate seen in July, it is “too premature” to say it has peaked, especially since, as winter approaches, gas prices could again rise.
The Bank of Korea raised interest rates by a quarter point at its last meeting to 2.5%, and said further increases of a quarter point “will be appropriate for some time as long as inflation paths remain as currently presumed.”
The stopping point, Rhee said, would hinge on how inflation behaves.
At this point, “I cannot say we are ahead of the curve,” Rhee said. “As long as inflation remains high, meaning 4-5% … then we will definitely continue to emphasize the normalization” of interest rates.
Inflation in Korea is expected to run at around 5% by the end of 2022, and fall through 2023. Its central bank, like many others, targets 2% inflation.
Rhee spoke on the sidelines of a Fed research conference where global central bankers used largely the same language to describe their common battle against rising prices. Though the headline problem is the same — inflation far beyond their established targets — the sources of price pressure and therefore the policy responses differ among countries.
For smaller open economies like Korea the situation is particularly complex because of the spillover effects from policies set elsewhere.
Even the fallout from Fed Chair Jerome Powell’s speech here on Friday, which sparked a sell-off in U.S. equity markets, would be watched, Rhee said, with an eye on how the won opens during Monday trading. The Fed chair promised U.S. interest rates would move to “restrictive” levels and remain there as long as needed to lower U.S. inflation.
The won has dropped about 11% against the dollar this year, and local officials have stepped up surveillance of the currency’s movements.
Rhee said so far he did not see the depreciation as driven by speculation or Korea’s economic fundamentals, but as part of the dollar’s rising global strength.
“There are a few days we see movement that’s too excessive – but so far I think our exchange rate movement is very much in line with major currencies,” Rhee said. “This depreciation pressure due to the dollar strength actually is a bad factor for our inflation, because our imported prices increase a lot,” he said, but “the current depreciation pressure does not mean any liquidity problems or solvency problems, or credit problem for Korea.”
Rhee said he risks from new geopolitical issues, with the Ukraine war sparking higher energy costs and tension between the U.S. and China.
“It’s is a huge downside risk for us – geopolitics and the US-China tension is I think a very important factor,” he said.
But he also said there was opportunity for Korea as the global economy reorganizes in the aftermath of the pandemic.
The chief priority now though is to defeat inflation, a problem shared across the globe even though the causes may differ.
“I can really see that the situation and challenges that the U.S. is facing are quite different from the headache and challenges that I am facing, and probably my European colleagues are facing,” Rhee said. But for each “it’s important for us to continue to prioritize inflation.”
(Reporting by Howard Schneider; Editing by Nick Zieminski)
