The interest rate gap between Korea and the US widened by 0.75%p... Is Han taking another 'big step'?

As the US took three consecutive giant steps (0.75% point increase in base rate at once) to catch the soaring inflation, the possibility of the Bank of Korea's big step (0.50% point increase) is growing little by little.

This is because, if the interest rate gap with the US, which has widened to 0.75 percentage points (p), is left unattended for a long period of time, foreign investment funds will flow out in pursuit of a higher rate of return, and the won's value will drop sharply, which in turn may encourage inflation.

If such signs appear before the monetary policy direction meeting of the Monetary Policy Committee (hereinafter referred to as the Monetary Policy Committee) on the 12th of next month, it is expected that voices from both inside and outside the BOK that "baby steps (a 0.25% point increase) are not enough" are expected to grow.

The US Federal Reserve (Fed) raised its benchmark interest rate target range by 0.75 percentage points from 2.25 to 2.50% to 3.00 to 3.25%, as expected at the regular meeting of the Federal Open Market Committee (FOMC) held on the 20th-21st (local time). I did.

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This is an unprecedented third consecutive giant step following June and July, indicating that the current inflationary pressure in the US is high.

In the same vein, the Fed also raised its inflation forecast for this year from 5.2% to 5.4%.

Moreover, given this price perception, the likelihood of the Fed taking its fourth giant step at the FOMC next month increases.

According to the dot plot reflecting the prospects of future interest rates by FOMC members, the US policy rate is expected to reach 4.4% by the end of this year.

With the Fed's third giant step, interest rates in Korea and the US inverted again after about a month.

After the Fed took the second giant step in July, the US benchmark interest rate (2.25-2.50%) surpassed Korea's (2.25%) for the first time in about two and a half years, until the Bank of Korea raised it by 0.25% on August 25th. We lost, but now the gap has widened again to 0.75 percentage points.

If on the 12th of the following month, the BOK Monetary Policy Committee takes only a baby step, and the Fed takes a giant step again in early November, the difference in interest rates between the two countries will increase to 1.25 percentage points.

Then, at the end of November, the MPC raised only 0.25 percentage points, and even if the Fed decides only the smallest big step in December, the gap will reach 1.50 percentage points.

Looking at past cases, the inversion phenomenon in which the US policy rate (base rate) exceeds that of Korea was observed from June 1996 to March 2001 (1st term), from August 2005 to September 2007 (2nd term), and 2018 It appeared three times from March to February 2020 (3rd term).

In particular, in the case of the first period, the US interest rate was up to 1.50 percentage points higher for six months (May to October, 2000).

The maximum reversal in the second and third periods was 1.00 percentage points (May-August 2006) and 0.875 percentage points (July 2019).

If the MPC continues to respond as a baby step to the successive giant steps or big steps in the US, the interest rate gap between the US and Korea is expected to reach an all-time high of 1.50 percentage points at the end of this year.

Due to this faster-than-expected monetary tightening in the US, the Bank of Korea Monetary Policy Committee has no choice but to raise the base rate at the two monetary policy direction meetings in October and November this year.

This is because, if the base interest rate is significantly lower than the US in terms of the won rather than the key currency (basic currency for international settlements and financial transactions) such as the dollar, the risk of foreign investment funds flowing out and the value of the won increases.

Moreover, as the won depreciates (the won/dollar exchange rate rises), the won-equivalent price of the same imported product rises, which may fuel the already soaring inflation.

Lee Chang-yong, governor of the BOK, also recently said in an interview with Reuters that "it is difficult to end the rate hike earlier than the US."

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Therefore, the market and economic agents are also prepared for the base rate to continue rising for the time being, but the problem is the extent of the increase.

After deciding on a 0.25 percentage point increase on the 25th of last month, Governor Lee decided that a gradual increase of 0.25 percentage points is appropriate as the current economic situation is not much different from the domestic price and growth trends expected in July. The key point is to raise them one by one,” he said.

However, if the domestic consumer price index in September does not clearly confirm that the price has passed the peak, foreign funds are withdrawn from the stock market and bond markets due to the widening gap between Korea and the US, or the won depreciation (depreciation) proceeds faster than expected. Following July, the second big step is expected to be inevitable.

When asked about the possibility of a big step last month, Governor Lee answered, "In principle, if there is a shock, we can consider it, but we do not consider it under the current situation."

In other words, if the unexpected shock becomes large, a big step cannot be ruled out.

In an interview with Bloomberg TV on the 29th of the same month, he said, "I don't want to make a promise in advance. Considering this uncertainty, we have to make a decision based on data," leaving room for big steps.