April 16, 2024

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Customers wait in line outside a branch of the Silicon Valley Bank in Wellesley, Massachusetts, Monday. (Reuters-Yonhap)

US Fed likely to hold back on rate hikes due to escalating volatility, giving room for BOK to keep its base rate unchanged

The abrupt fallout from the Silicon Valley Bank collapse has led to raised bets that the US Federal Reserve will be less aggressive in raising interest rates, lifting the burden on the Bank of Korea, which was under pressure from the widening key rate gap.

Prior to the banking crisis that hit the financial market on Friday, the market had been expecting the Fed to raise the base rate by 50 basis points this month. Fed chair Jerome Powell had been giving hawkish guidance in past weeks, warning the market that its fight against inflation is not yet over.

The situation, however, seems to be at a turning point with the SVB collapse and its ripple effects. As the bank’s collapse partly stemmed from steep rate hikes, the market expects the Fed to take a step back in its aggressive monetary policy stance, going for a quarter-point move.

If the Fed does not deliver a "big step" rate hike involving 50 basis point raise at this month's meeting for March. 21-22, this will impact the BOK's decision slated for next month.

The central bank was pressured to raise its key rate due to the widening gap between the base rates of the two countries that could cause capital outflow and increase market volatility.

Though the BOK has assured it will not “mechanically” follow the Fed’s rate decision, the gap pressures Korea with currency risk. In February, the Korean won against dollar weakened after the central bank froze the rate in response to the slow economy.

“With the SVB crisis, the Fed will drop its 50-basis-point rate hike.” Lim Jae-kyun, an analyst from KB Securities, said.

"The Fed will not go for a 50 basis point raise, considering financial stability. This pulls down the projection for the US terminal rate from 6 percent to 5.25 percent."

“The BOK will see no need to raise the rate,” Lim said, adding the expectation that the central bank will not further raise the rate until the end of this year.

The current gap in the rates between the two countries goes up to 1.25 percentage points with Korea’s base rate standing at 3.5 percent and the US’ at 4.5-4.75 percent.

The Fed's 50-point move will widen the gap up to 1.75 percent, surpassing the previous record gap set at 1.5 percent in 2000. A 25 basis point raise will lead to a 1.5 percent gap.

If the Fed slows its rate hike, the BOK will have some time to monitor the effects of previous rate hikes, as previously mentioned by its BOK Gov. Rhee Chang-yong. Rhee said the central bank will keep a watch on disinflation and its effects, after delivering the bank’s decision to keep the rate unchanged last month.

However, the concern to fight the ongoing inflation still remains. Amid high inflation, both countries’ state banks have stressed price stabilization to be their foremost agenda.

The minutes of the BOK's Monetary Policy Board meeting from Feb. 23 released Tuesday showed most board members agreed the terminal rate should be higher than the current 3.5 percent, leaving some room behind for further rate hikes in near future.

In addition, though Korea may have passed its inflation peak, the US consumer price index released Tuesday shows that the war against hot inflation is not yet over.

The CPI rose 6 percent on-year in February. Though the figure shows a slight decline from the 6.4 percent in January, it still remains well above the 2 percent annual target set by the Fed.

Furthermore, while the Fed may slow its rate hike this month, it will not easily drop its inflation-fighting efforts, possibly leading to further rate hikes throughout the year. Therefore, pressure on the BOK may return soon.

“The prices are considered first of all, followed by financial stability, currency and other factors,” BOK Governor Rhee Chang-yong said at a recent debate regarding the base rate policy. “As there is still some time until the (rate-setting) meeting in April, we will make a decision considering various pieces of data.”

By Im Eun-byel (silverstar@heraldcorp.com)