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Bank of Korea hikes interest rate by 25 bps, likely to hike twice in 2018

On Thursday morning, the Bank of Korea hiked its policy rates by 25 basis points to 1.50 percent. Rebounding economic outlook, strong trade performance and gradually rising inflation are amongst the reasons for the first rate hike since 2011.

Meanwhile, the market sees Bank of Korea’s governor Juyeol Lee as a hawk. This might be another reason for today’s decision making. But the central bank’s statement appears to be slightly dovish as the policy makers stated that an accommodative bias would be mentioned as demand-driven inflationary pressures would not be solid for some time, noted Commerzbank in a research report. Therefore, the Korean won depreciated following the central bank’s decision.

The BoK governor noted that the rise in interest rate would assist in preventing future financial imbalances. According to a Scotiabank research report, the central bank is expected to adopt a cautious approach to monetary tightening in the quarters ahead.

“We forecast two more rate hikes over the course of 2018—likely to take place in the second and fourth quarters—taking the policy rate to 2.0 percent by end-2018”, stated Scotiabank.

The South Korean economy is believed to be prepared for a gradual rate hike cycle. The nation’s economic growth has been robust. The real GDP grew 3.6 percent year-on-year in the third quarter of this year, exceeding consensus and policymakers’ expectations. Activity is widespread with accommodative fiscal and monetary policies underpinning domestic demand.

Consumer sentiment is solid, suggesting that household spending might maintain its momentum in the quarters ahead. Strong business confidence and solid external sector activity would support facilities investment, while a rise in global demand might continue to support the nation’s exports.

“We forecast the country’s real GDP growth to average 3.1 percent y/y in 2017, up from the 2.8 percent pace recorded in 2016. We estimate that South Korea’s negative output gap has fully closed following the strong GDP advance in the third quarter”, added Scotiabank.

This is likely to set off a gradual rebound in demand-driven inflationary pressures in the quarters ahead. The headline inflation is expected to be slightly below the central bank’s 2 percent inflation target in the near term, but price pressures are expected to intensify gradually from the second quarter of next year. However, a tighter monetary policy stance might help in maintaining the headline rate below 2.5 percent year-on-year through 2019.

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