Bloomberg News

Bank of Korea May Need to Slow Rate Rise Pace, Kang Says

June 17, 2011

(Updates with IMF report in the tenth paragraph.)

June 17 (Bloomberg) -- The Bank of Korea may need to slow the pace of interest-rate increases after its fifth move since July 2010 last week because of rising risks to the global economic outlook, a board member said.

“The external conditions are much more uncertain -- if the uncertainty deepens, we may have to slow down our pace,” Kang Myung Hun, one of six policy makers who votes on rates, said in an interview at his office in Seoul yesterday. Kang also cited the danger of boosting rates so quickly that the bank detonates a household-debt “bomb” that causes a property-market crash.

Kang’s view reflects concern across Asia that the world economic outlook is deteriorating, with the Reserve Bank of India yesterday citing increased unease over the European debt situation. China and the Philippines have opted for raising bank-reserve ratios in the past week rather than benchmark lending rates.

Inflation pressures have prompted Asian central banks to be among the quickest to withdraw monetary stimulus as growth accelerated following the 2008 world recession, and Kang yesterday indicated the BOK will have more work to do.

“I don’t think we can tackle mounting inflation expectations with this one hike,” said Kang, 57, referring to the BOK’s rate increase on June 10. “Although I voted for an increase this time, this does not mean that I’m more optimistic about the economic outlook,” he also said.

Stocks Decline

South Korea’s benchmark Kospi index of stocks has retreated six of the past seven weeks, part of a global drop in equities as investors discount a deteriorating economic outlook. The U.S. unemployment rate climbed above 9 percent in May, adding to headwinds for the recovery of the world’s largest economy.

“My biggest worry is the U.S. economy,” Kang said. “A double-dip slowdown is not likely. But if the U.S. goes into a deeper soft patch, we may have to move much more slowly with fewer steps.”

Bank of Korea Governor Kim Choong Soo and his board raised the benchmark seven-day repurchase rate to 3.25 percent last week as consumer-price gains exceeded the bank’s 4 percent target limit since January and core inflation excluding volatile food and energy items accelerated to a two-year high.

South Korea’s economy expanded 1.3 percent in the three months through March, the fastest since the second quarter of 2010. The unemployment rate unexpectedly fell to a six-month low of 3.3 percent in May, countering slowdowns in industrial production growth and exports. The won has also gained 4.5 percent against the dollar in the past three months, threatening the profits of exporters.

IMF Call

The International Monetary Fund today urged South Korea to pursue “further steady monetary tightening” to combat inflation, adding that “monetary conditions remain loose.” The fund expects the economy to expand 4.5 percent this year and 4.2 percent in 2012, according to a report released by the nation’s finance ministry in Gwacheon, south of Seoul.

Kang, a Seoul National University graduate, holds a PhD in economics from the State University of New York at Albany. He spent most of his career in academia before joining the central bank board in late April 2008 with the finance ministry’s recommendation.

Kang is viewed as “the most dovish” of the six-member board, according to Wai Ho Leong, a senior regional economist at Barclays Capital in Singapore. He has been the lone dissenter, or one of only two dissenters, in favor of cutting rates or holding them instead of raising them, in eight of 39 rate decisions since he joined.

More Communication

Kang also said that the central bank needs to communicate more effectively with investors on its policy direction after economists’ median forecasts of rate decisions have been wrong for seven of the past 12 meetings.

“I’m surprised that market has been wrong so often in predicting the rate decision,” he said. “At the same time, market players should remember that the decision is currently made by six members, not only by the governor.”

Kang said that while higher interest rates are needed to help deflate South Korea’s record household debt levels, a careful and comprehensive response is needed to avoid causing a crisis. Household debt rose to a record 801.4 trillion won ($738 billion) in the first three months of this year.

“A sharp increase in interest rates may burst the household-debt problem,” Kang said. “If the debt-bomb blows, builders and lenders will be crippled and property market will crash when people start to sell off their homes to repay debt.”

The board member indicated that a “neutral” level for the BOK’s benchmark rate, a term that refers to a stance that fosters growth without causing inflation to accelerate, is less than 4 percent.

“It should be higher than the current 3.25 percent but it may not be as high as 4 percent as others say,” Kang said. “The estimate derives from the past growth and inflation trajectory but we may have to figure out a new normal level after the global financial crisis.”

--Editors: Chris Anstey, Lily Nonomiya

To contact the reporters on this story: Eunkyung Seo in Seoul at eseo3@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net


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