BOK in danger of falling behind curve
By Kim Jae-kyoung
When it comes to monetary policy, there is conventional wisdom. “Take action in a preemptive manner.” Every central banker is well aware of this well-known principle ― the problem is that it is easy to talk but hard to act for many reasons.
Monetary policy can be comparable to a card game. In a game of cards, if you are able to read others’ hands, you win. The same goes for monetary policy. If the central bank is lacking in the art of rhetoric, it fails to have the intended impact on the economy.
In this regard, the Bank of Korea (BOK) has been always a target of criticism since Governor Kim Choong-soo took the helm. On the surface, the dovish governor has been trying to stay firm on inflation control, but his actions have hardly preempted the market.
The BOK hiked its policy rate by 25 basis points Thursday to 3 percent. The increase came as no surprise as recent comments from Korean policymakers suggested a hike was inevitable due to surging inflation. Kim told the National Assembly, Wednesday, that price stability was the BOK’s most important mandate.
Ironically, following the action, the central bank is faced with a myriad of criticisms from economists and analysts. They say that Korea’s central bank is falling behind the curve, voicing concerns that it could pose a threat to local assets.
“I think the BOK is in danger of falling behind the curve. Core inflation has accelerated sharply in the last two months and I expect it will accelerate again in March when the increase in education components is felt in the consumer price index (CPI),” ING Group senior economist Tim Condon told The Korea Times.
“BOK-behind-the-curve concerns are a threat to risk assets down the road. The won is a risk asset and I think such concerns will keep it in a 1,100-1,130 range in the first half of 2011,” he added.
What is of more concern this time is that the move came after the government started ringing the alarm bell. Strategy and Finance Minister Yoon Jeung-hyun said Wednesday that inflationary pressure was adding uncertainties to the economic recovery.
This suggests two important messages. One is that inflation has already reached a serious level. Policymakers from the government don’t like to talk about inflation because they always want to boost economic growth. The other is that the move is too late and the central bank again failed to take action preemptively.
“The BOK moves too late to tame inflation. We believe the BOK has been behind the inflation-fighting curve so far. Apart from oil prices, the success of the rate hikes to limit inflation depends on the transmission mechanism of monetary tightening, especially through the exchange rate channel,” Nomura Securities economist Kwon Young-sun said.
“For example, if the local currency does not appreciate by as much as we forecast, to 1,020 won (to the dollar) by the end of 2011, due to sizable net capital outflows or policy mistakes, we see CPI inflation rising over 5 percent in 2011,” he added.
Policymakers should remember that what matter most are inflation expectations rather than inflation figures themselves. Once expectations soar, this leads to an upward price spiral. Unfortunately, Korean consumers are already feeling the pinch from inflation.
“The jump in core CPI means inflation is already affecting most consumers. Thus, inflation expectations are rising and are being reflected in consumer sentiment surveys. The upward price spiral, sustaining inflation at a high level, will threaten the economy,” Morgan Stanley economist Sharon Lam said in her contribution to The Korea Times.
“It is not just about import prices. Korea needs to stop inflation expectations from soaring in order to halt the upward price spiral. A consistent policy stance is needed to manage consumer expectations on inflation,” she added.
In order to prevent these expectations from going out of control, the BOK is highly expected to hike key rates again in the months to come. Most economists expect another rate hike in April or May.
Condon said, “The next move will come in April as there is some urgency for the BOK to normalize the rate. I expect another 75 basis points of tightening by August,” he said.
Kwon also said that given its forecast that CPI inflation will rise further in the coming months, he expects the BOK to deliver two more 25 basis point rate hikes, in May and July, taking the policy rate to 3.5 percent.
“We expect the BOK to then pause for the rest of 2011, as we expect GDP growth momentum to slow in the second half due to weaker domestic demand, before hiking again by another two 25 basis point moves to 4 percent in the first half of 2012 as growth momentum rebuilds,” he said.
Behind other countries
The BOK is also behind its counterparts from emerging countries both in terms of frequency and amplitude. The BOK has raised its policy rate by a total of 100 basis points to 3 percent from the record low of 2 percent in February, 2009.
In contrast, Brazil and Israel have taken more bold moves by hiking key rates by 300 basis points and 200 basis points, respectively, compared to their record low levels. Australia and India, both, raised the rate by 175 basis points.
It is hard to compare one country to others because every economy is in different situation. However, one thing that is obvious is that now is time for Governor Kim to turn more hawkish and become an inflation fighter to keep inflation in check.
The central bank should not sit back and wait for international food and commodity prices to go down. The government cannot rely on the won’s appreciation to tame inflation because it will be ineffective and too costly, given the nation’s declining current account surplus and capital outflow.