Interest rate hikes' primary goal is inflation; economy is a variable

The Bank of Korea's Monetary Policy Board has signaled a strong intention to raise interest rates, even though the benchmark rate was held steady in its last meeting. The board utilized forward guidance, including upward adjustments to its dot plot for interest rate projections six months ahead, to signal that rate hikes are imminent and could form a cycle.

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The most difficult thing in monetary policy is when multiple objectives conflict, leading to uncertainty about the direction, but this time is an exception. The path is clear, whether looking at inflation or growth.

Bank of Korea Governor Shin Hyun-song's remarks have drawn particular attention. He suggested that future rate increases might not be a one-off event but could establish a "cycle." Shin stated that unlike situations with conflicting policy objectives, the path forward is clear regarding both inflation and growth. This contrasts with the typically ambiguous language used by monetary authorities when discussing future policy directions.

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The first objective of this interest rate hike is, of course, to curb inflation. Price pressure has spread across the board due to high oil prices resulting from the US-Iran war, and expected inflation has also risen significantly. There is no doubt that 'interest rate hike = inflation control.'

The market is interpreting these signals as a potential for rate hikes to continue into the following year. The primary objective of these potential rate hikes is widely understood to be curbing inflation, which has been exacerbated by high oil prices stemming from geopolitical tensions like the US-Iran conflict. However, Shin's comments suggest that the motivation might extend beyond just inflation control. The apparent lack of concern regarding potential negative impacts on economic growth fuels speculation that the bank aims to "raise rates higher and for longer" to secure greater monetary policy flexibility.

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However, upon careful consideration of Governor Shin's remarks, it is difficult to dismiss the suspicion that the purpose of this interest rate hike is not solely limited to curbing inflation. It gives the impression that concerns about growth, which are often cited as a side effect of raising interest rates, are practically not an issue.

This perspective is supported by recent economic data. The Bank of Korea revised its economic growth forecast for the year upward significantly, from 2.0% to 2.6%, and is reportedly considering further upward revisions. First-quarter growth, boosted by a semiconductor boom and improved trade conditions, reached 17.1% year-on-year in nominal terms. These figures suggest a potential for overheating rather than a slowdown, making the timing and extent of any rate hikes a critical consideration for the bank, balancing inflation control with economic stability.

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The Bank of Korea first considers inflation when deciding on the base interest rate. However, once a decision is made to raise rates, the pace and intensity are adjusted based on economic indicators such as growth and employment. If the plan is for a robust cycle of rate hikes, then the economy would be as important a factor for review as inflation.